Pcln Equity Research Report

Rating: BUY*

Price (23 Nov. 15): $1,520

Target Price: $1,750

52-week Price Range:

Market Cap: 75.56B

*Target Price is for 12 months.

Research Analyst:

Shreya Rajbhandary

Business Description: The Priceline Group is the world's leading provider of online travel and related services. It functions as an intermediary in transactions between travelers and travel service providers. Services are provided through 6 primary brands. Since being founded in 1997, and going public in 1999, the Priceline Group has grown into the world's third-biggest e-commerce company after Amazon and Alibaba. Priceline and rival Expedia are the global leaders in the online travel agency (OTA) business, and have converted the industry into a duopoly. Priceline's global focus and efforts of acquiring and developing European and Asian travel brands has diversified it into an international business with a presence in over 200 countries.

QUALITY

Business Quality: The Priceline Group's dominant position in the OTA industry has been a result of the success of Booking.com. In 2005, the Priceline Group acquired the European hotel booking website for $135 million. During 2015, international business (the substantial majority of which is generated by Booking.com) represented 86% of Priceline's revenue. Priceline has successfully exploited the markedly different European travel industry. In U.S., branded hotels dominate the market, whereas Europe is comprised mostly of independent operators. With over 1 million properties and strong network effects, Booking.com enjoys an estimated 41% of Europe's €43.9 billion air travel and hotel bookings. This has helped Priceline jump from a profit of $10 million in 2003 to $9.8 billion last year. With its growing financial strength, Priceline has been able to buy competition, substitutes, and growth opportunities. It has acquired Kayak, RentalCars, OpenTable, Agoda, and CTRIP, to become a one shop stop for all travel related services.

Industry Analysis: The OTA industry is a mature industry with only two main players, Priceline and Expedia. They compete for volume of transactions but avoid compressing margin. Priceline's international focus and Expedia's domestic focus has also abated the competitive rivalry in the industry. Supplier power and buyer power are both low because of high switching costs associated with moving away from the infrastructure associated with OTCs. Threat of new entrants is low as it the industry is a duopoly and the standard practice is to buy potential competition as they gain a strong user base. The major threat of substitutes is to a lesser extent Airbnb (that serves individual homeowners), but suppliers who seek to book users directly. Booking directly with travel suppliers is less convenient, but hotels and airlines are pushing campaigns to steer bookings to their own sites to reduce fees. This trend has gained some traction in 2016 and could become a problem for the industry leaders.

Management Quality: Former CEO and Chairman Jeffery Boyd, who led the company from 2002 to 2013, is acting as the interim CEO as Priceline looks for a new leader. Previous CEO Darren Huston resigned in April of this year, following an investigation that found he violated the company's code of conduct when he had a personal relationship with an employee. While management change is always tricky, the resignation was not caused by operational or financial issues. Furthermore, current management's strong track record provides assurance to any doubts regarding their ability to lead the company. During Boyd's leadership, the company's stock jumped from $10 to more than $1,000. Other top management that includes CFO Daniel Finnegan, Priceline CEO Brett Keller, and Booking CEO Gillian Tans, have played a major role in Priceline's growth with an average tenure of 14.25 years in the company's 19-year history.

Financial Quality: Priceline has consistently improved its operating and net margin over the last 5 years. FCF has been on an uptrend and FCF margin has averaged an impressive 32.4% during the past 3 years. Aided by high profitability, Priceline has been growing its equity base at 30% over the period. FCF combined with additional debt has been used to fund recent acquisitions. The company's cash ratio fell significantly from 4.76 two years ago to 1.98 at the end of June and Debt-to-EBITDA from 0.63 to 1.95. Still the company has a coverage ratio of over 18%, more than enough to cover its short-term needs.

GROWTH

Historical Growth: The initial primary growth driver for Priceline was the switchover from traditional travel agents to online transactions. On the company level, Booking.com provided exponential growth. However, it is obvious that sales growth of over 30% and EBIT growth of over 50% is unmaintainable over any long period. While these factors remain growth drivers, growth rate from 5 or 10 years ago is impossible. Growth rate has steadily declined since 2011. However, Priceline has sustained impressive double-digit growth in this period, even when dollar appreciation created major headwinds in the last two years. The company is pursuing new avenues of growth that will allow it maintain its double-digit growth.

Expected Growth: Analysts expect 5-year growth rate of 16.0% for Priceline. The major catalysts for this growth will be growth in Asia, rise of non-hotel hotels, and improved operating margins. Bookings in Asia-Pacific are expected to grow from $48 billion in 2015 to $72 billion in 2017. The growth is expected to continue at 20 percent CAGR through the next decade. Priceline is well positioned to take advantage of this through its Singapore-based OTA, Agoda and its 15% stake in China-based CTRIP (the fastest growing and third largest OTA).

Priceline also sees Airbnb's success as an opportunity to expand further into the vacation rental market. Unlike Airbnb that serves individual homeowners, Booking.com does business exclusively with property management companies. It charges commission instead of fees and allows a customer to book a property instantly. Booking.com already has nearly half a million vacation rentals, and boasts the best traffic acquisition and conversion in rentals of alternative accommodations. This category of rental reservations is expected to grow at 34% annually over the next 3 years.

Lastly, operating margins look to expand as the online ad war between Priceline and Expedia has ended in a truce. Priceline's ROI from ad spending stabilized in Q1 2016, with EBITDA rising for the first time in 5 years.

MOMENTUM

Priceline has been one of the best performers in the SP500 index over the last 5 years with a total return of 177%. In the last year, macroeconomic concerns had bogged down the stock but it has returned 22% ytd (most of it coming post-Brexit).

The negative sentiment surrounding the stock began last year when Priceline, citing currency headwinds, released guidance in November 2015 with Q4 expected EPS between $11.10 and $11.90, well below the $12.42 analysts were looking for. The stock dropped over 30% in the next 3 months. However, the guidance was too pessimistic; Priceline reported earnings of $12.63 which sent the stock price soaring back up. Another sell off occurred post-Brexit in June.

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