Priceline (NASDAQ:PCLN), the world’s largest online travel agency by sales, continued to deliver better than its quarterly guidance with 27% y-o-y increase in revenues ($1.68 billion) in Q2 2013. The company had earlier forecasted revenue growth in the range of 15%–22%. KAYAK, the leading meta-search engine in US, contributed $31.1 million (excluding inter-company transactions) in revenues to the Priceline group since its date of acquisition (May 21, 2013). 
Worldwide gross bookings grew sharply by 38% y-o-y to $10.1 billion on the back of 38% and 46% jump in hotel reservations and rental car days, respectively. While domestic gross bookings rose 12% owing to increased supply of hotel inventory and higher advertising spend on Booking.com and Priceline.com, international gross bookings grew 44% due to expanding presence in high-growth markets.  Unlike its closest competitor, Expedia (NASDAQ:EXPE), Priceline’s results were largely unaffected by TripAdvisor’s transition to meta-search and adverse economic conditions in Europe. (Read: Expedia’s Stock Shows Warning Signs As Competition Sinks Results)
International Expansion Is The Key To Priceline’s Success
The acquisition of Booking.com, Agoda and TravelJigsaw, has significantly helped Priceline in expanding its international business. International bookings, which account for about 85% of the company’s total gross bookings, continued to lead the growth like previous quarters with 44% annual increase in Q2 2013. Although outperformance in high-growth markets such as Asia-Pacific and South America has been the major driver behind this trend, Booking.com’s strong growth in the core European market has also contributed significantly. 
The fragmented European hotel market and increasing per capita income in emerging economies provide tremendous growth opportunities for travel agencies. Internet penetration in these economies is relatively low, but is expected to rise at a fast pace. Priceline is rapidly expanding into international markets and adding hotel supply to leverage the trend. Its Booking.com brand now has 330,000 hotels and accommodations, up 40% compared to last year. Agoda is also gaining preference as a leading site among Asia-Pacific bookers.
Additionally, Priceline is planning to build out Rentalcars.com into a global brand by replicating its successful expansion strategy for Booking.com and supporting this with higher advertising and marketing spend. The management believes that it could also help KAYAK expand across the globe by providing it necessary resources that were not available to it as a separate company.
Higher Advertising Spend Is Not Allowing Room For Improvement In Operating Margins
Online travel service 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. This has impacted both gross and operating margins of many industry players.
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 on it in Q2 as well. As a result, offline advertising expense increased more than three-fold year-on-year to about $32 million. The company intends to continue its investment on TV advertising in the U.S. for Booking.com in Q3 2013. The inclusion of KAYAK will further add to the offline spend. Online advertising expense stood at $460 million, increasing by about 50% y-o-y due to lower ROI (return on investment) on online advertising, brand mix within the Priceline group and channel mix within certain of its brands. The company expects these trends to continue in the foreseeable future as well. 
Higher online and offline advertising expenditure led to a decline of 410 basis points in operating margin in Q2 2013. Although we believe that the higher spend will help drive future growth in gross bookings, we estimate Priceline’s EBITDA margin will remain more or less around the present level for the rest of our forecast period.
We are in the process of updating our price estimate of $642 for Priceline based on its recent quarterly results and the acquisition of KAYAK.Notes: