Priceline’s Growing Dependence On Europe Is Hurting Margins

Priceline (NASDAQ:PCLN) is one of the leading Online Travel Agencies (OTA) in the world. Over the years it has seen a steady decline in its hotel revenue margins, which is the revenue earned by Priceline as a percentage of hotel gross bookings. In addition to increasing competition from others OTAs and higher direct selling via suppliers’ websites, the rising proportion of booking on Priceline’s websites via the agency model is the primary factor behind the declining revenue trend.

Priceline makes travel bookings under two models – the agency & merchant models. Under the agency model, net revenues are generated in the form of commissions and bookings fees which results in lower revenue margins. On the contrary, in the merchant model a user bids for services and the booking is completed on Priceline’s website itself, which offers scope for charging higher margins.

Hotel bookings are the most important segment in Priceline’s portfolio with a more than 85% contribution to its valuation as per our estimate. While we believe that the hotel revenue margins will continue declining, we forecast the rate of decline to slow down over our review period.

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Priceline’s Expanding International Operation; Agency Model Is More Popular In Europe

Increasing its international footprint, especially in Europe, has been one of the key factors behind Priceline’s robust growth. With the acquisition of Booking.com, Agoda and TravelJigsaw, Priceline’s gross bookings from international markets as a percentage of total bookings have gone up from 55% in 2007 to around 82% in 2012. Booking.com has been one of the primary drivers for OTA growth in Europe and key European markets represent approximately 60% of Priceline’s total booked room nights.

Booking.com primarily markets hotel rooms under the agency model, whereas in the U.S. the merchant model is more dominant. Thus, the rising proportion of bookings from Europe has put downward pressure on hotel margins earned by Priceline.

Source: Priceline’s Annual Reports

The online travel sales in Europe increased from $118 billion in 2010 to $141 billion in 2012, and are estimated to reach approximately $180 billion by 2016. ^[1] The fragmented European hotel market and comparatively lower Internet penetration provide tremendous growth opportunities for OTAs. Thus, Europe remains an important market for Priceline and the company intends to continue focusing on expanding its footprint in the region. Booking.com only accounts for 6% of the European hotel market which leaves great potential for further growth. ^[2]

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 agency model.

Factors That Can Stabilize The Decline In Hotel Revenue Margins

Here are some of the factors which we believe will ease pressure off margins in the long-run:

– Increasing competitiveness in the U.S. – Expedia (NASDAQ:EXPE) is the most popular OTA among American users with a 43% market share in the U.S. gross booking as compared to Priceline’s 11% market share in 2012. ^[3] We think that Priceline’s recent acquisition of Kayak will help the company make a deeper foray in the U.S. travel market as Kayak accounts for more than 50% share of the U.S. meta-search market. ^[4] By attracting more traffic to Priceline’s website, Kayak’s acquisition can increase the company’s booking transactions in the region.

– Higher penetration in Asian markets – Bookings made on Agoda.com in the Asia-Pacific region are under the merchant model, and thus a higher proportion of booking from Asia can help stabilize revenue margins. Though Priceline does not disclose its proportion of revenues earned from Asia, we believe that the Asian online travel market will remain an important destination for Priceline for years to come. The increasing per capita income in emerging economies as well as the potential increase in Internet penetration (27.5%) in the region, compared to the U.S. (78.6%) and Europe (63.2%), presents a huge upside to the online travel industry in general.

– Introducing new opaque booking options: In addition to its popular “name your own price model”, Priceline introduced a new opaque booking option called “express deals” in July last year. Under the “name you own price” the buyers bids a price and is only made aware of the hotel’s star level and neighborhood. On the other hand, under “express deals” one can see the price but not the name of the hotel until you make a non-refundable payment though the user can view the star rating as well as the neighborhood where the hotel is located. In light of the tough macroeconomic scenario, an increasing number of travelers are opting for the opaque booking option, which offers discounts as high as 50% over traditional online booking options. A continuous innovation in its opaque booking platform can help Priceline make higher bookings via the merchant model.

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. On the contrary, if the hotel revenue margin declines to 15% there will be a greater than 10% downside to our price estimate for the company.

We have yet to account for Kayak’s acquisition in our model.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Online Travel Sales Explode in Latin America, eMarketer, November 20, 2012 [↩]
2. Booking.com big for Priceline but only scratching the surface in Europe, Tnooz, February 29, 2012 [↩]
3. Priceline, Travelocity take steps to increase share, Travel Weekly, February 5, 2013 [↩]
4. With Kayak In The Bag Priceline’s U.S. Business Looks Stronger, Business World, June 3, 2013 [↩]