Priceline Group Inc. (PCLN)

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WHAT HAS CHANGED?

Priceline's growth story continued for the first nine months of 2016. While the company's accommodation platform, booking.com, continued expanding in the last quarter, the platform is also making investments on newer products to improve its services and offerings. Priceline.com continued with its improvement plans and announced Brett Keller as its new CEO. Kayak's healthy growth continued and currently it is expanding to crucial regions such as Asia and Latin America. However, in Q3 2016, the only glitch in Priceline's performance came from OpenTable which incurred a $941 million non-cash impairment charge against its goodwill, and subsequently dampened Priceline's net income.

Priceline experienced moderate growth in 2015. The company reported revenue of $9.2 billion, reflecting 9% year-on-year growth. This was aided by a 10% increase in the gross bookings to $55.5 billion. (Gross bookings refers to the total dollar value, generally inclusive of all taxes and fees, of all travel services purchased by its customers.) The growth was aided by increases in hotel room nights and rental car days partially dampened by the decline in airline ticket volumes. The effects of this revenue growth also boosted the bottom line. Priceline's growth was also fueled by its strategic investments in recent times. Priceline witnessed robust hotel booking growth on its booking.com platform. Booking.com is presently looking into more aggressive penetration into the single-owner, single-room market. Some of the reasons for booking.com’s widespread popularity are its wide range of accommodation offerings, not charging a booking fee (most OTAs charge a 5% to 15% booking fee), and instantly confirming reservations as opposed to a 24 hour confirmation time taken by other websites. The accommodation booking website crossed 100 million customer accounts in 2015 and witnessed its one billionth guest stay. However, unfavorable currency exchange rates continue providing some headwinds to Priceline's financial performance.

  1. Priceline's Booking.com Is The Current Leader In Online Accommodation Booking

    • Booking.com has been the biggest growth driver for Priceline, so far. Booking.com released its bookable room figure for the first time in November 2015 – 21 million rooms across 820,000 unique properties.
    • Booking.com also has several competitive advantages over its peers -– unlike most OTAs which charge a 5% to 15% booking fee, Booking.com doesn't charge a booking fee from travelers, also Booking.com's reservation are instantly confirmed, as against a 24 hour confirmation time taken by other sites. Hence, from all aspects combined, Booking.com is indeed, currently, the online accommodation market leader.
    • After the launch of BookingSuite, which is successfully driving growth in the B2B sphere, Priceline had recently launched Booking.com for Business. Targeting the corporate travelers and travel organizers, the tools in this website allows corporate travel bookers to link travelers to their company accounts, keep track of travel spending through budget filters, and travel reports, and other such features which are especially attractive to the business travelers.
  2. Priceline Agreed To Feature On TripAdvisor's Instant Booking Platfrom

    • In October 2015, Priceline entered into an agreement to display some of its accommodation properties on TripAdvisor‘s Instant Booking platform. Priceline’s other websites are also expected to participate on Instant Booking, in the future. The presence of the world's largest OTA on its platform was a big development for TripAdvisor, which for so long only displayed hotels on its platform.
  3. Priceline's Plans In China

    • In August 2014, Priceline strengthened its commercial partnership (initiated in 2012) with Ctrip, by investing $500 million in the company. Priceline now has access to Ctrip's 100,000 accommodations in the Greater China region, while Ctrip has access to Priceline's global portfolio of over 500,000 accommodations.
    • In May 2015, Priceline announced its investment of an additional $250 million in Ctrip via a convertible bond. Post the deal, Priceline could gain up to 15% of a stake in Ctrip.
    • In its Q3 2015 call, mentioning the recent Ctrip-Qunar partnership and Ctrip's purchase of ~40% of eLong's stake, Priceline's management mentioned that although the developments are favorable to bring a sustainable business environment in China, Priceline is not solely dependent on Ctrip for its expansion plan in the country. In 2015, Booking.com increased its properties from 8,000 to 25,000 in China. Chinese travelers are globally the most significant right now, and are primary inbounds in most of Priceline's important destinations.
  4. Priceline's plans to expand OpenTable internationally

    • Priceline's OpenTable helps restaurants fill tables by offering online reservation services to diners. The acquisition (made in 2014) marked Priceline's entry into the online restaurant reservation business, a category in which OpenTable is a leader in North America, with over 50% market share.
    • Priceline has made significant investments towards shifting the OpenTable B2B software into a modern, cloud-based platform. The company has envisioned international expansion plans for OpenTable in 2015.
    • In September 2015, Priceline acquired AS Digital, an Australian-based restaurant reservation website on September 3rd. AS Digital will be integrated with OpenTable, and this will help build OpenTable’s presence in Australia, Japan, and across the Asia Pacific region. TripAdvisor has, so far, been holding the leading position in restaurant booking websites outside the U.S. with its multiple acquisitions over the last year. Priceline might provide additional competition to TripAdvisor on the international front with its recent acquisition.
  5. Reserves for strategic investments

    • In February 2015, Priceline decided to raise $1.13 billion through a public offering of senior notes. In March 2015, it announced a second set of senior notes offerings, subject to market conditions. It intends to use the fund for general corporate purposes, including share repurchases, paying down debt, and making acquisitions. Priceline spent around $2.5 billion net of cash acquired, on acquisitions in 2014. Priceline had around $10 billion cash on hand at the end of 2015.
  6. Priceline's 'Name Your Own Business' is dampening domestic growth

    • Priceline's domestic business is being hampered by its diminishing opaque business. In the United States, Priceline enables its customers to purchase a full range of travel services under the traditional price disclosed model (in which it earns a commission) or lets them bid for services at discounted prices under Name Your Own Price model, where it earns the difference between the price an individual is willing to pay and the price charged by the travel service establishment (hotel, airlines, etc). Under Priceline's proprietary Name Your Own Price service, customers can quote their own price for a travel product (hotel room stay, air ticket, etc). Priceline matches the quotes with the discounted, but otherwise undisclosed, fares provided by the suppliers and determines whether to accept the booking without disclosing the identity of the supplier.
    • One of the primary reasons for waning demand for the opaque model is that shoppers aren't aware of the quality of the travel product purchased, until they have paid for it. This uncertainty about quality has worked against the model.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Hotel Bookings

Priceline's Market Share of Occupied Hotel Rooms: We currently forecast Priceline's share of the global occupied hotel rooms to increase from 11% in 2015 to ~15% by the end of our forecast period. There could be around 15% downside to the Trefis price estimate if the market share were to remain flat (at the current level) over our forecast horizon.

Revenue Margin on Hotel Bookings: We currently forecast the revenue earned by Priceline as a percentage of the size of hotel booking to decline from 16% in 2015, to 15% by 2022. There could a marginal upside if the revenue margins remain around the current level during our forecast period.

EBITDA Margin: We currently forecast Priceline's EBITDA Margin from Hotel Bookings to marginally increase from 38% in 2015, to 39% by the end of our forecast period. There could be a marginal downside to the Trefis price estimate if the EBITDA Margin were to remain flat over our forecast horizon.

BUSINESS SUMMARY

Priceline is the largest online travel company in the world (in terms of gross bookings). It provides its customers a broad range of travel services, which include bookings for hotel stays, airline tickets, car rentals, restaurant reservations, cruises and vacation packages via its online travel portals: priceline.com, booking.com, agoda.com, rentalscars.com, opentable.com, breezenet.com, and lowestfares.com. Its websites connect travelers with suppliers of different travel products such as hotels, airlines, cruises, and car rental companies.

In the U.S., Priceline enables its customers to purchase a full range of travel services under the traditional price disclosed model (in which it earns a commission) or lets them bid for services at discounted prices under 'Name Your Own Price' model, where it earns the difference between the price an individual is willing to pay and the price charged by the travel service provider (hotel, airlines etc).

Under Priceline's proprietary 'Name Your Own Price' service, customers can quote their own price for a travel product (hotel room stay, air ticket, etc). Priceline matches the quotations with the discounted, but otherwise undisclosed, fares provided by the suppliers and determines whether to accept the booking, without disclosing the identity of the supplier. Customers opting for this service are expected to be flexible in terms of the date and time of travel and other specifications. Bookings once made, under 'Name Your Own Price' service cannot be canceled and no refunds are offered. The advantage of this service is that it lets suppliers sell excess inventory (hotel room stays, air tickets, etc) without harming their existing retail pricing structure while offering leisure travelers highly discounted prices in exchange for some flexibility in their itineraries.

SOURCES OF VALUE

We believe that International Business and Hotel Bookings are the main sources of value for Priceline -

  1. High Growth in the Online Travel Industry Outside the U.S. (International Business)
    • With the acquisition of Booking.com, Agoda, and TravelJigsaw, Priceline has been focusing on developing its international operations. Priceline's international business constituted approximately 87% of its gross bookings in 2014, as compared to 70% in 2010.
      • The rising income levels and expanding middle class, combined with high population growth rates in emerging economies such as China, India, and South-East Asia is expected to contribute to an increasing number of people traveling to and from these regions.
      • The extremely competitive online travel industry in the U.S. has led to lower revenue margins and high promotional spending, thereby eroding operating margins in the industry. Priceline's key rival, Expedia, recently acquired its marketing partner Travelocity, and intends to acquire Orbitz (the third largest OTA player in the U.S.) soon, among others.
      • The relatively low internet penetration in Europe (63.2%) and Asia Pacific (27.5%) as compared to the U.S. (78.6%), presents a huge upside to the online travel industry in these countries, as customers increasingly access the internet for making travel plans.
      • The lack of standardization in travel services outside the U.S., along with a fragmented lodging industry in Europe and Asia Pacific, leaves much scope for premium pricing. Hence, Priceline stands to make higher revenue margins from its international business.
  2. Higher Revenue Margins from the Hotel Business
    • Hotel bookings offer online travel agencies (OTAs) markedly higher revenue margins (~19%), compared to other travel segments - air ticket bookings (~3%), car rentals and cruises (~9%).
      • Priceline's opaque bookings model - 'Name Your Own Price' - facilitates even higher premium pricing, leading to revenue margins in excess of 30%. Hence, Priceline's strategy of focusing on the hotel bookings segment is in line with its stated goal of 'being the leading worldwide online travel reservation service.'
      • Priceline’s significant share of the relatively lesser competitive, and massive hotel business abroad, combined with high growth, will keep revenue margins of the hotel business at the higher end. Priceline.com competes with the leading online travel agencies in the U.S. for sale of airline tickets, car rentals, and package services. Relatively smaller share of the saturated domestic market, and intense competition for Priceline will restrict any potential growth in revenue margins of non-hotel businesses.

KEY TRENDS

The following factors determine the fate of the online travel industry:

  1. Macroeconomic Environment
    • Due to the discretionary nature of leisure travel, the online travel service providers, which earn revenue in the proportion (and as a percentage of) travel bookings, depend entirely on the macroeconomic conditions (employment levels, inflation rates, etc). Corporate travel is, in fact, one of the indicators of economic activity and is influenced the most by the ongoing macroeconomic conditions. During a recessionary period, both corporate and leisure travel plummet. Amid rising unemployment and declining disposable income levels, the consumers cut back on their travel plans first before making adjustments to other expenses.
    • Advertising, which constitutes a significant source of revenue for the online travel service providers, too, depends on the level of business activity. During recessionary times, businesses cut back on media and advertising spending and this translates into lower online advertising revenue for travel portals such as expedia.com, priceline.com, etc.
  2. Foreign Exchange
    • Leisure travelers, unlike corporations, do not hedge themselves against foreign exchange fluctuations. Hence, the spot foreign exchange rates determine the consumer demand for international travel. In times of adverse foreign exchange rate movements (such as a depreciating dollar), international travel becomes dearer, and the same hotel booking and air tickets cost more dollars, thereby discouraging travel bookings.
    • Travel Service Providers, such as Priceline, earn revenues from international bookings in foreign currencies, incur most operating expenses in dollars, and report the earnings in dollars. Thus, any adverse foreign exchange movement could erode profits. Since an increasing proportion of bookings are coming from the less penetrated emerging economies, the exposure to foreign exchange is only expected to increase in the future.
  3. Fuel Prices
    • Rising fuel prices has the immediate impact of increasing airfares, which discourages travel. This not only impacts Air Ticket bookings but reduced travel also negatively impacts hotel bookings, and destination services such as car rentals and cruises. Decline in overall bookings impacts travel service providers' revenues.
    • With a rise in fuel prices, airlines are no longer able to offer significant discounts on bulk bookings to travel agents such as Expedia. With the result that the revenue margins earned by travel service providers (under Merchant model) take a hit. The lower revenue margins translate into lower profit margins for the travel service providers.
  4. Impact of Unforeseen Events on the Travel Industry
    • Events which are beyond the control of any travel services provider, and can critically impact travel, include terrorist attacks, unusual weather patterns, and natural disasters such as hurricanes, tsunamis, volcanic eruptions (April 2010, volcanic eruption in Iceland), travel related health concerns such as Influenza H1N1, avian bird flu, SARS, etc, political unrest, and other unpredictable events. Unlike other industries, such events have a very significant impact on travel bookings and consequently on the revenues of travel service providers.
  5. Internet Penetration
    • While 78.6% of the U.S. population has internet access, the proportion of Europe’s population online is 63.2%, with the internet penetration in Asia being even lower at 27.5%. Hence, with rising affluence in emerging economies of South Asia, and increasing adoption of internet and e-commerce, the proportion of travel bookings over the internet is expected to rise in the future, a trend which favors online travel providers such as Expedia, Priceline, Travelocity, and Orbitz.
  6. Airline Industry
    • Fuel expenses constitute the single largest cost head for airlines, making them vulnerable to hikes in crude oil prices. To reduce vulnerability to fuel price volatility, many airlines engage in fuel price hedging.
    • Demand for flights is highly correlated to the global economic growth. Thus, a decline in economic growth, or recession, reduces demand for flights, impacting passenger traffic for airlines. On the contrary, steady growth in the global or U.S. economy, grows demand for air travel, allowing airlines to raise their air fares, occupancy rates, and profits.
    • Many airlines are figuring out ways to grow their top lines through ancillary means such as baggage fees, access to on-board WiFi/food/drinks, etc. Accordingly, airlines are investing to enhance their product offerings that include in-flight WiFi and other entertainment options, improved lounge facilities, and extra legroom seats.
    • During the past decade, low cost carriers such as Southwest and JetBlue have gained significant market share in the U.S. Looking ahead, we figure these low cost carriers to continue to grow their market share, as their lower fares attract passenger traffic.
    • The U.S. airline industry has seen many mergers and acquisitions in the last decade including the five big combinations of US Airways and America West, Delta and Northwest, United and Continental, Southwest and AirTran, and American and US Airways. A more consolidated industry has worked to improve profits of all airlines. Fewer players in the market has made it easier for those remaining airlines to add capacity with restraint. Prior to this consolidation in the airline industry, individual airlines were adding capacity at higher rates in an attempt to grow their market shares. This rapid capacity addition resulted in an oversupply of seats, reducing margin and profits of all carriers. Going forward, we believe as long as airlines add capacity with discipline, the industry will remain profitable overall.

  7. Hotels and Lodging Industry
    • During the recessionary period of 2008-2009, as travel declined as a whole, so did the hotels' occupancy rates (the proportion of hotel rooms occupied per year). To meet the operating expenses (since the hospitality business has a significantly higher proportion of fixed costs), the hotel owners resorted to offering discounts and lower tariffs. This led to a drop in the Average Daily Rate (the average rate per night of hotel booking). The Hotels Bookings took a hit and adversely impacted the revenues for travel service providers.
    • Hotel Bookings offer markedly higher Revenue Margin (Revenue earned by the travel service provider as a percentage of the size of booking) at over 19% compared to Air Ticket bookings (~3%), Cruises and Car Rentals (~9%).
    • The hotels market in Europe and Asia is much more fragmented with smaller, independent lodgings compared to the U.S., where the hotel market is dominated by large hotel chains. Hotel chains are more likely to offer online bookings through their own websites, while online travel agencies such as Expedia are more appealing to small, independent hotels outside the U.S. Also, travel agencies stand to make higher revenue margins from independent budget hotels under their merchant business model. Hence, expansion into hotels in Asia and Eastern Europe presents a growth opportunity to the U.S. based online travel services providers.
  8. Online travel services is a highly competitive niche segment within the travel industry
    • Competition in the U.S. online travel industry remains intense, and traditional online travel companies are creating new promotions and consumer value features in an effort to gain a competitive advantage over competitors.
    • In June 2007, Priceline eliminated processing fees for its price-disclosed airline ticket service, and in April 2008, it reduced processing fees for its domestic price-disclosed merchant hotel room service. Starting in March 2009, Expedia and Travelocity also eliminated air booking fees, and in April 2009, Orbitz followed. In April 2009, each of Expedia and Orbitz reduced booking fees on hotel room reservations. With the result, no one player could maintain a price advantage over the others on price-disclosed merchant air tickets and hotel room reservations and the online travel industry as a whole lost revenues.
    • In October 2009, Travelocity announced the waiver of its cancellation and change fees for hotel and vacation packages, as well as an expanded hotel guarantee, under which consumers who book a hotel room, and then find a lower published rate for the same room anytime before the day of check-in, are eligible to receive a refund of the difference.
    • Since consumers are now increasingly hunting for bargains and discounts, Traffic obtained through online advertising has increased as a percentage of total demand, since the same consumer visits several websites before making a purchase. This increased shopping behavior has reduced advertising efficiency and effectiveness as traffic obtained through online advertising becomes less likely to result in a purchase on the web site. Therefore, online advertising expenses have increased at a faster rate than gross profit, a trend which is expected to continue.
  9. Threat from Online Search Engines
    • Large, established Internet search engines, with substantial resources and expertise in developing online commerce and facilitating Internet traffic, are creating and intend to further create inroads into online travel, both in the U.S. and internationally.
    • Google's acquisition of ITA Software, Inc., a major flight information software company, has enabled it to create its own flight search tools which enable users to find flight information on the Internet without using the services of Expedia or Priceline, etc. Google has also invested in HomeAway, a vacation home rental service.
    • In addition, Google has launched a travel “meta-search” site to show searchers specific hotels and rates in addition to text advertisements.
    • Microsoft has launched Bing Travel, a “meta-search” site, which searches for airfare and hotel reservations online and predicts the best time to purchase them. “Meta-search” sites leverage their search technology to aggregate travel search results for the searcher’s specific itinerary across supplier, travel agent, and other websites and, in many instances, compete directly with online travel service providers.

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