City officials for some large U.S. cities are claiming that leading online travel agencies such as Expedia (NASDAQ:EXPE), Priceline (NASDAQ:PCLN), Travelocity and Orbitz (NASDAQ:OWW) are collecting state and local hotel occupancy taxes from consumers and remitting only a fraction of the same to the government, resulting in large tax losses [1] [2] This is an issue that has surfaced in the past and has received renewed attention given a recent ruling in Texas.
We have a price estimate of $30.60 for Expedia, which is slightly ahead of the current market price.
How does the alleged tax evasion work?
The hotels offer online travel agencies (OTAs) hotel room bookings at a discount to the otherwise published retail price. While the OTAs earn a margin on every booking, the hotels are able to target higher occupancy levels by distributing hotel room-nights through third parties with access to a wider audience. But here’s the catch…
Assume that the OTA offers a room to the consumer for $100 per night. It levies a hotel occupancy tax, which varies between states and cities, at say 10% amounting to a gross booking of $110 ($100 + $10 for hotel tax). Say, the hotel offers the OTA the room booking at a 25% discount, the OTA pays the hotel $75 ($100 minus 25% discount). It is alleged that the OTA pays the local government $7.5 (10% of $75 actually paid to the hotel) instead of the $10 it had collected from the consumer and claims the $2.5 differential as a processing fee. And it is this differential that amount to tax losses to the government as appears in the form of higher commission to the OTA.
How does this impact OTA’s stock?
We forecast the commission (say ‘r%’) on hotel room bookings to decline from around 24% in 2010 to almost 22% by 2017, the end of our forecast period. However, current estimates are higher due to the aforementioned differential that exists between the hotel occupancy tax (say ‘t%’) charged to the consumer and that actually paid to the government. If found guilty and forced to pay higher hotel occupancy taxes, the OTAs shall witness a marginal decline in the commission they earn on hotel bookings. We did the math and deduced that the commissions could squeeze by r%*t% / (1+t%) percent points.
How much could be the impact on Expedia?
However, given that Expedia draws about two-thirds [3] of its bookings from the US, the decline in commissions shall be (2 / 3) * r% * t% / (1+t%) percent points.
For Expedia’s commission on hotel bookings of close to 23% and an approximate hotel occupancy tax of 5.875% (as in New York City) [4], it amounts to commissions shrinking by ~0.85% resulting in a 2% potential downside to our current $30.60 Trefis price estimate of Expedia’s stock.
You can drag the graph below to see the impact on Expedia’s stock price estimate.
View our detailed analysis for Expedia here
Notes:- Judge: Websites owe Texas cities full hotel taxes, Forbes citing AP [↩]
- Ruling could spell end of OTA merchant model, Lodging Industry Website [↩]
- Expedia strengthens its Brazilian operations, eyefortravel.com, Aug 18’ 2011 [↩]
- 1871 House [↩]
