Despite macro headwinds and unfavorable exchange rates, leading online travel agency (OTA) Priceline (NASDAQ:PCLN) marked a 21% and 34% increase in its 2012 revenues ($5.3 billion) and net income ($1.4 billion), respectively. Robust growth in hotel room nights, an expanding international footprint and its increasing investment in developing alternate user platforms have been the key factors driving Priceline’s global growth. Priceline’s stock price has increased by approximately 30% since the start of the year and crossed the $800 mark last month.
While we maintain a positive outlook for the company’s long term potential, we think the current growth rate is difficult to sustain in the long run and estimate this to slow over our review period. Our price estimate of $642 for Priceline is at a discount of over 20% to the current market price.
Here are certain factors that we believe can limit Priceline’s growth rate in the future.
Increasing Competition Could Limit Priceline’s Growth In Europe
With the acquisition of Booking.com, Agoda and TravelJigsaw, Priceline has significantly expanded its international business. Gross bookings from international markets as a percentage of total bookings have gone up from 55% in 2007 to around 82% in 2012. While Priceline continues to focus on leveraging higher travel demand from Asia, its expanding presence in Europe has been the driving force behind its strong growth.
With a lower online penetration (compared to U.S.), a fragmented hotel market and low OTA penetration in Eastern Europe, we believe that the European online travel market offers considerable growth opportunities for OTAs. Priceline, Expedia (NASDAQ:EXPE), Lastminute.com, Ebookers and ODIGEO account for over 60% of European OTA bookings. Despite accounting for only 6% of the European hotel market, Priceline’s Booking.com has been one of the primary drivers for OTA growth in Europe. 
In addition to numerous locally based OTAs, Priceline faces increasing competition from other leading U.S. based OTAs, including Expedia (hotels.com) and Orbitz (Ebookers), who are also targeting growth in the European travel market. In December 2012, Expedia announced its acquisition of Trivago, which is one of the leading meta-search engines for hotel bookings in Europe. Established in 2005, the website now has over 600,000 hotels across 140 booking sites in 30 countries. We feel that apart from marking Expedia’s entry in the meta-search space, Trivago would help fuel Expedia’s strategy to leverage growth in the European hotel market.
While Priceline has been successful in expanding its foothold in Europe and may continue doing so, we feel the intense competition in the European market may restrict Priceline’s future growth.
Expedia Still Remains The Preferred OTA In The U.S.
Though Priceline overtook Expedia as the world’s OTA by sales in 2010, Expedia remains the most popular OTA among American users. Expedia has a 43% share of U.S. gross booking as compared to Priceline’s 11% market share in 2012. 
The U.S. online travel market is growing at the slowest pace compared to other economies such as Europe, Latin America and Asia-Pacific. Nevertheless, with estimated revenues of $151 billion in 2012, the country remains the biggest market in terms of online travel sales and will continue to be so for years to come. 
We believe that Kayak’s acquisition will help Priceline make a deeper foray in the U.S. travel market, as the former accounts for a more than 50% share of the U.S. meta-search market.  We believe that by attracting more traffic to Priceline’s website, Kayak’s acquisition can increase the company’s booking transactions in the region. However, it might take a while for Priceline to close Expedia’s lead in the market.
Declining Revenue Margins On Hotel Bookings
Contributing over 85% to Priceline’s valuation, we estimate hotel bookings to be the most important division in Priceline’s portfolio. With over 20% revenue margins (commission earned per hotel booking), hotel booking is also the most profitable division compared to airlines (~2%) and car rentals & cruises (~9%). Priceline continues to build on its worldwide hotel supply platform and currently has over 275,000 hotels, and other accommodations in 180 countries and territories, up 41% annually.
Priceline’s hotel revenue margins have declined from 39% in 2007 to 21% in 2012, as per our estimate. The main reason for the decline is the rapid growth in international markets where the agency model of bookings is more popular. In the agency model net revenues are generated in the form of commissions and booking fees resulting in lower revenue margin. Priceline’s proportion of gross bookings from the agency model has increased from 74% in 2007 to 84% in Q1 2013. We expect the decline in commissions to continue in the future due to intense competition from other OTAs, as well as supplier websites and increasing proportion of bookings coming from the emerging markets.
If Priceline’s hotel revenue margin remains constant at the current level then there will an upside of around 10% to our price estimate for the company.
Operating Margin To Remain Under Pressure
Priceline’s operating margin has continuously increased between 2007-2012, albeit at a declining pace. However, its operating margin declined by 70 basis points annually in Q1 2013. Priceline launched its first offline advertising campaign to build the Booking.com brand in the U.S. and continued to spend aggressively to build its international operations.
Though the high operating expenses put pressure on operating leverage, Priceline intends to continue investing in product development and customer acquisition to drive future growth. Since it currently has a insignificant market share in some international regions which offer tremendous opportunities, we expect Priceline to continue investing in building its global image. Priceline expects gross margins to remain under pressure in Q2 2013.
The online travel services is a highly competitive niche segment with stiff competition among OTAs. In an effort to gain a competitive advantage, travel companies have expanded their advertising budgets, and are creating new promotions and consumer value features such as eliminating processing fees, waiving cancellation and change fees, etc.
Though we believe that high expenditure incurred will help drive future growth, we estimate Priceline’s EBITDA margin to remain more or less around the present level for the rest of our forecast period. If Priceline manages to increase its operating margin to 45%, there will be a 15% upside to our current price estimate.
We have yet to account for Kayak’s acquisition in our model.Notes:
- Booking.com big for Priceline but only scratching the surface in Europe, Tnooz, February 29, 2012 [↩]
- Priceline, Travelocity take steps to increase share, Travel Weekly, February 5, 2013 [↩]
- Online Travel Sales Explode In Latin America, eMarketer, November 20, 2012 [↩]
- With Kayak In The Bag Priceline’s U.S. Business Looks Stronger, Business World, June 3, 2013 [↩]