Priceline Group Inc. (PCLN)

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WHAT HAS CHANGED?

Priceline's 2016 ended on a strong note and the trend seems to be continuing in the first quarter of 2017 as well. Priceline's Booking.com – globally, the most popular online accommodation booking platform – added over 289,000 accommodation properties to its platform in 2016, reflecting a 33% growth, and ended the year with around 1.15 million properties. Priceline's vacation rental properties grew by 49% to 591,000 properties in 2016. The management believes that not charging a booking fee like other competitors such as AirBnb and Expedia's HomeAway, might have helped this growth. One of the highlights of its earnings call was that most of the Priceline Group's growth was organic. The teams behind each of its brands built the supply inventories in their respective platforms, instead of growing through acquiring other brands.

In 2016, Priceline's gross travel bookings amounted to around $68 billion, reflecting a 23% y-o-y growth. Its gross profit rose by 20% y-o-y to ~$10 billion and its international operations contributed around 90% to this. The management expects the strong growth to continue in Q1 2017 as well, with around 20% to 25% growth in room nights and a 17% to 22% growth in gross bookings.

  1. Most brands under the Priceline Group grew successfully in 2016

    • The company's Priceline.com brand made significant progress with its revamp initiatives that was going on through 2016 including the improvement of technology and customer experience on the desktop and mobile platforms. Last year this brand also announced Brett Keller as its new CEO.
    • Kayak, Priceline's metasearch arm, entered Asia Pacific and Latin America last year. This year, Priceline announced the decision to acquire The Momondo Group, the parent company of Momondo and Cheapflights, for a cash sum of $550 million. This marked the biggest acquisition for Priceline since its OpenTable acquisition for $2.6 billion in 2014. The main goal behind this acquisition is being touted as entry into markets where Kayak doesn't enjoy a strong presence, including the UK and the Nordics, where The Momondo Group's brands are popular. Another reason for the acquisition might be to pose a stiff competition to flight metasearch engines such as Skyscanner (which was recently acquired by Ctrip). Ctrip is currently the second largest OTA in terms of market value with a 10% market share in the online flight booking market. With Ctrip's backing, the Edinburgh-based Skyscanner can grow even stronger. Hence, Priceline's acquisition in the same region might help it to compete with Ctrip's Skyscanner.
    • Priceline's travel fare aggregator and metasearch engine, Singapore-based Agoda, also performed well overcoming challenges in the markets where it operates.
    • Its Rentalcars.com, the world's largest car rental company, grew well despite challenges including the impact of Brexit. Rentalcars.com increased mobile bookings, enhanced user experience, and grew its supplier base.

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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