INTRINSIC VALUE ASSESSMENT OF

EXPEDIA, INC. (EXPE)

JANUARY 19, 2019 This article was written with Stephen Barnes from The Investor’s Podcast

IntroductionExpedia,Inc.isanonlinetravelcompanythatprovidesleisuretravelersandbusinesseswiththetechnology,tools,andinformationtheyneedtoplan,book,andexperiencetravel.Expediaownsandcontrolsabroadportfoliooftravelbrandsandistheworld’slargesttravelagencybybookings.

Expediaderivesthemajorityofitsrevenuesfromlodgingandaccommodationsservices(68%ofsalesin2017).Theremainderofitsrevenuesisderivedfromservicesforairtickets(8%),rentalcars,cruises,in-destination,andothers(13%),andadvertising(11%).

TravelsuppliersdistributeandmarketproductsviaExpedia’sdesktopandmobileofferings(apps),aswellasthroughalternativedistributionchannels,andExpedia’sprivatelabelbusiness.Expediaalsooperatesanadvertisingandmediabusinessthathelpsotherbusinesses,mainlytravelproviders,reachalargeaudienceoftravelersaroundtheglobe.

Source:ExpediaInc.,InvestorPresentationofFebruary8,2018

INTRINSIC VALUE ASSESSMENT OF

EXPEDIA, INC. (EXPE)

Expedia’sportfolioofbrandsandbusinessesincludethefollowing,amongothers:

• Expedia.com®,aleadingfull-serviceonlinetravelcompanywithlocalizedwebsitesin33countries;• Hotels.com®,aleadinggloballodgingexpertoperating90localizedwebsitesin41languageswithan

award-winningloyaltyprogram(booktennights,getonefree);• Expedia®AffiliateNetwork,aglobalB2Bbrandthatpowersthehotelbusinessofhundredsofleading

airlines,travelagencies,loyalty,andcorporatetravelcompaniesplusseveraltopconsumerbrandsthroughitsAPIandtemplatesolutions;

• trivago®,aleadingonlinehotelmetasearchplatformwithwebsitesin55countriesworldwide;• HomeAway®,aglobalonlinemarketplaceforthevacationrentalindustrywithnearly1.8million

onlinebookablevacationrentallistings,whichalsoincludestheVRBO,VacationRentals.com,andBedandBreakfast.combrands,amongothers.Thesebrandscompetewiththepopularandfast-growingAirbnb.Inadditiontoitsonlinemarketplace,HomeAwayalsoofferssoftwaresolutionstopropertymanagersthroughitsHomeAwaySoftwareandGladtoHaveYouproducts.OnOctober25,2018,ExpediaalsoannouncedtheacquisitionofPillowandApartmentJet,whichwillbefoldedintoHomeAwayportfolioofcompanies;

• Egencia®,aleadingcorporatetravelmanagementcompany;• Orbitz®andCheapTickets®,leadingU.S.travelwebsites,aswellasebookers®,afull-servicetravel

brandwithwebsitesinsevenEuropeancountries;• Travelocity®,aleadingonlinetravelbrandintheUnitedStatesandCanada;• Hotwire®,aleadingonlinetravelwebsiteofferingspontaneoustraveldeals;• Expedia®MediaSolutions,theadvertisingsalesdivisionofExpedia,Inc.thatbuildscreativemedia

partnershipsandenablesbrandadvertiserstotargetahighly-qualifiedaudienceoftravelconsumers;

Source:ExpediaInc.,InvestorPresentationofFebruary8,2018

INTRINSIC VALUE ASSESSMENT OF

EXPEDIA, INC. (EXPE)

TheCompany’scurrentmarketcapisabout$17.01Billion,anditsenterprisevalue(i.e.,marketcap+totaldebtnetofcash)isapproximately$18.77Billion.Duringthemostrecenttwelve-monthperiod,itgenerated$15.7Billioninsalesand$1.2Billioninleveredfreecashflow(i.e.,afterinterestexpense),or$1.5billioninunleveredfreecashflow(i.e.,beforeinterestexpense).Thecompany’scommonstockhasfluctuatedbetweenahighof$139.77andalowof$98.52overthepast52weeksandcurrentlystandsataround$114.56.IsExpediaundervaluedatthecurrentprice?

The Intrinsic Value of Expedia, Inc.TodeterminetheintrinsicvalueofExpedia,we’llstartbylookingatthecompany’shistoricalfreecashflow.Acompany’sfreecashflowisthetrueearningswhichmanagementcaneitherreinvestforgrowthordistributebacktoshareholdersintheformofdividendsandsharebuybacks.BelowisachartofExpedia’sfreecashflowforthepasttenyears.

Asonecanseefromthechartabove,thecompany’sfreecashflowhasgrownoverthelasttenyears,from$361millionin2008to$1.2billioninthetwelve-monthperiodthroughSeptember2018.Inotherwords,freecashflowgrewatacompoundannualgrowthrate(CAGR)of12.76%overthepasttenyears.

TodetermineExpedia’intrinsicvalue,anestimatemustbemadeofitspotentialfuturefreecashflows.Tohelpusbuildthisestimate,wehavecalculatedanddisplayedanarrayofpotentialoutcomesforfuturefreecashflowsbelow.

INTRINSIC VALUE ASSESSMENT OF

EXPEDIA, INC. (EXPE)

Whenexaminingthearrayoflinesmovingintothefuture,eachonerepresentsacertainprobabilityofoccurrence.Theupper-boundlinerepresentsa12%growthratewhichisslightlylessthanthe12.76%compoundedannualgrowthrate(CAGR)achievedoverthepasttenyears.This12%growthratehasbeenassigneda30%probabilityofoccurrenceasitiscertainlypossible,butperhapsnotthemostplausiblescenariosincecompaniestypicallygrowslowerandslowerastheymatureandasrevenuesgetlarger.However,inExpedia’scase,threefactorsargueinfavorofa12%growthrate.

First,themarketinwhichitcompetesishuge.Theglobaltravelmarketwasestimatedtobeabout$1.6trillionin2018,andtheonlinetravelsegmentofthatmarketisstilllessthanhalf(44%oftheglobaltravelmarket)andevenasmallerpercentageoutsidetheU.S.(7%inEMEA,6%inLATAM,and5%inAPAC).

Source:ExpediaInc.,InvestorPresentationofFebruary8,2018

INTRINSIC VALUE ASSESSMENT OF

EXPEDIA, INC. (EXPE)

Second,duringthefive-yearperiodfrom2013through2017,revenuegrewataCAGRof22%whileAdjustedEBITDA(somewhatofaproxyforcashflow)grewataCAGRof18%.

Source:ExpediaInc.,InvestorPresentationofFebruary8,2018

Third,certaincapitalexpenditures,suchasdatacenterinvestments,areshrinkingasExpediamigratestothecloud.

Source:ExpediaInc.,InvestorPresentationofFebruary8,2018

INTRINSIC VALUE ASSESSMENT OF

EXPEDIA, INC. (EXPE)

Toaccountforanumberoffactorsincludingfiercecompetitionandpromotionalactivityamongbrandedfoodmanufacturersandprivate-labelproductsasretailersconsolidate,offsetsomewhatbypotentialrevenueandearningsincreasesfromfutureacquisitions.

Themiddlegrowthlinerepresentsa7%growthratetoaccountforanumberoffactorsincludingfiercecompetitionintheonlinetravelspaceandtheplausibilityofslowingglobaleconomicgrowthand/orarecessioninthenearterm.Expedia’scompetitorsincludewell-capitalizedonlineandofflinetravelcompanies,largeonlineportalsandsearchwebsites,certaintravelmetasearchwebsites,mobiletravelapplications,socialmediawebsites,aswellastraditionalconsumere-Commerceandgroupbuyingwebsites.Themiddlegrowthscenariohasbeenassigneda60%probabilityofoccurrence,asitismostlikelytooccur.

Thelowerboundlinerepresentsa3%growthrateinfreecashflowandassumesthatthecompanywillgrowataboutthesamerateasthe10-YearTreasuryNote,whichisagoodproxyforprojectedGDPgrowth(i.e.,thegrowthoftheoveralleconomy)overthenexttenyears.Expediaisverylikelytogrowatleastasfastastheoveralleconomy.Thisscenariohasbeenassignedonlya10%probability,asthecompanywillmostlikelygrowmuchfasterthantheoveralleconomygiventhevastmarketinwhichitcompetesandtheglobaltrendfromofflinetoonlinebookings.

Assumingthesepotentialoutcomesandcorrespondingcashflowsareaccuratelyrepresented,Expediamightbepricedtogeneratea9.4%annualreturnifthecompanycanbepurchasedattoday’spriceof$117.Let’snowtakealookatanothervaluationmetrictoseeifitcorrespondswiththisestimate.

BasedonExpedia’scurrentearningsyield,whichistheinverseofitsEV/EBITratio,thecompanyiscurrentlyyielding4.5%.ThisisbelowtheConsumerDiscretionarySectormedianaverageof7.6%suggestingthatthecompanymaybeovervaluedonacomparablebasis.However,ExpediahasacurrentEV/LTMFreeCashFlowyieldof7.1%.ThisisabovetheConsumerDiscretionarySectormedianaverageof5.3%suggestingthatthecompanymaybeundervaluedonacomparablebasis.Finally,we’lllookatExpedia’sfreecashflowyield,ametricwhichassumeszerogrowthandsimplymeasuresthefirm’strailingfreecashagainstitscurrentmarketpriceormarketcapitalization.Atthecurrentmarketprice,Expediahasafreecashflowyieldof6.9%comparedto5%fortheConsumerDiscretionarySector.

Takingallthesepointsintoconsideration,itseemsreasonabletoassumethatExpediaiscurrentlytradingatadiscounttofairvalue.Furthermore,thecompanymayreturnaround9.4%annuallyatthecurrentpriceiftheestimatedfreecashflowsareachieved.Now,let’sdiscusshowandwhytheseestimatedfreecashflowscouldbeachieved.

The Competitive Advantage of Expedia, Inc.Expediahasvariouscompetitiveadvantagesoutlinedbelow.

• BrandValue.OneofExpedia’smostpowerfulcompetitiveadvantagesisitsportfolioofrecognizablebrands.Expediasellsitstravelofferingsundernumerousleadingandtrustedbrands(seethelistofbrandsintheintroductionsectionabove).Expediacanleveragethesebrandstogarnertrustwithcustomerswhenmakinglargetravelpurchases.

INTRINSIC VALUE ASSESSMENT OF

EXPEDIA, INC. (EXPE)

Source:ExpediaInc.,InvestorPresentationofFebruary8,2018

ForacompetitortochallengeExpedia’scompetitivebrandposition,theywouldhavetodeployalargeamountofcapitalandresourcesonadvertising,customerservice,anddistribution.Infact,in2017,Expediaspent$4.36billionondirectsellingandmarketingactivities.

• StrongNetworkEffects.Expediahasbuiltandcontinuestobuild,abroadnetworkoftravelofferings.Onthesupplyside,asofSeptember30,2018,thecoreExpediaplatformexhibited895,000properties,andHomeAwaysportednearly1.8millionbookablelistings.Onthedemandside,asmeasuredbyAppAnnieonOctober25,2018,Expedia'scoreplatformranksasatop-10journeyiOSmobileapplicationin17countriesversus118forBooking.com,and25forTripAdvisor.

Source:ExpediaInc.,InvestorPresentationofFebruary8,2018

ThisstrongnetworkeffecthasledExpediatobecomeoneoftwodominantplayersintheglobalonlinetravelagencybookingmarket—theotherplayerbeingBookingHoldings(formerlyknownas

INTRINSIC VALUE ASSESSMENT OF

EXPEDIA, INC. (EXPE)

Priceline).ExpediaandBookingeachhaveabout35%shareintheglobalonlinetravelagencybookingmarket.Thenumberthreeplayer,Orbitz,wasacquiredbyExpediain2014.BeneathExpediaandBooking,marketshareishighlyfragmented,makingitveryhardforsmallerplayerstogaincustomertrafficandsupplierscale.Smallerplayerswouldneedtoexpendlargeamountsofcapitalandsubstantialhumancapitaltobuildrelationshipswithhotelsandgathercriticalaccommodationinformation,includingpictures,justtogetstarted.Then,toattractcustomers,theywouldneedtospendheavilyonadvertisingtoattractcustomerstotheirapporwebsite(asmentioned,Expediaspentover$4.3billionor43%ofrevenueondirectmarketingin2017).Andevenifasmallerplayermanagedtoattractafewcustomers,itwouldneedtobuildoutITsystems,datacenters,anda24/7customersupportteamtoretainthem.Notaneasytask!

• SwitchingCosts.Finally,Expedia’sscaleallowsittoeconomicallyofferrewardsandloyaltyprogramstoitscustomers.OnceExpediawinsacustomer,itsrewardsandloyaltyprogramsincentivizethecustomertobookwithExpediaoroneofitsbrandsagainandmakeithardtoswitchtoacompetitor.Forinstance,Hotels.comRewards®,theloyaltyprogramestablishedin2008,offerstravelerstheabilitytoearnonefreenightforeverytennightsstayed.IpersonallyhavetakenadvantageofthisrewardsprogramandwasreluctanttobookahotelthroughanysiteotherthanHotels.com.BeyondHotel.comRewards®,ExpediaoffersExpedia®+rewardsonover30BrandExpediapointsofsale,aswellasOrbitzRewardsonOrbitz.com.

Expedia, Inc.’s RisksNowthatExpedia’scompetitiveadvantageshavebeenconsideredlet’slookatsomeoftheriskfactorsthatcouldimpairourassumptionsofinvestmentreturn.

• Potentialcompetitionforwell-capitalizedmegacompanies.Expediamayencountermeaningfulcompetitionoverthenexttenyearsfrommegacompaniesthatalreadyhavethepocketbooksandusertrafficnecessarytobuildnetworkscaleandthedesiretoentera$1.6trillionmarketforthesakeofgrowth.ThesepotentialnewentrantsincludeGoogle,Facebook,Amazon,Alibaba,Baidu,TripAdvisor,andhotelconsortia.Focusedentrybyanyoneofthesecompetitorscouldleadtoindustrycommodificationandmargincontraction.Thatsaid,themarketcanprobablysupportsomelevelofincreasedcompetitionoverthenextseveralyears,asthetravelbookingmarketisextremelylarge,at$1.6trillion,andonlinepenetrationofthetravelmarketremainslow,especiallyoutsidetheUnitedStates.

• GrowthinAlternativeAccommodationsMarket.Theexplosivegrowthexperiencedoverthepastfewyearsinthealternativeaccommodationsmarket(thinkAirbnb)hastakenmanytravelcompaniesbysurprise.ContinuedgrowthandtransitiontowardalternativeaccommodationscouldhamperExpedia’scoreplatformbusiness.However,thismaybeoffsetbyExpedia’sHomeAwaysegment,whichcompetesinthealternativeaccommodationsspaceanddirectlyagainstAirbnb.Infact,Expedia’sHomeAwaysegmenthasexperienced35%year-over-yearrevenuegrowthand66%year-over-yearAdjustedEBITDAgrowthoverthelasttwoyears.Inthemostrecentquarter(endingSeptember2018),HomeAwayaccountedforapproximately12%oftotalrevenue,upfrom10.3%ayearago.

• LowerBookingsinEconomicDownturn.Finally,aneconomicdownturncouldnegativelyimpactExpedia’sresults.Thetravelindustryiscyclicalandaffectedbychangesineconomicgrowth.Duringeconomicdownturns,consumershavetypicallycutleisuretravelbeforemanyotherexpenses.Duringthe2009downturn,whenExpediawasstillayoungandgrowingcompany,saleswereflat.Ifadownturnweretooccurtoday,nowthatExpediaismature,itwouldprobablyexperienceadeclineinsales.

INTRINSIC VALUE ASSESSMENT OF

EXPEDIA, INC. (EXPE)

Opportunity CostsWheneveraninvestmentisconsidered,onemustcompareittoanyalternativestoweighuptheopportunitycost.Atthetimeofwriting,10-yeartreasuriesareyielding2.731%.Ifwetakeinflationintoaccount,therealreturnislikelytobecloserto1%.TheS&P500IndexiscurrentlytradingataShillerP/Eof28.5whichis69.64%higherthanthehistoricalmeanof16.8.Assumingreversiontothemeanoccurs,theimpliedfutureannualreturnislikelytobe-2.8%.Expedia,therefore,appearstoofferamuchbetterreturnforinvestorsatpresent,butotherindividualstocksmaybefoundwhichofferasimilarreturnrelativetotheriskprofile.

Macro Factors Investorsmustconsidermacroeconomicfactorsthatmayimpacteconomicandmarketperformanceasthiscouldinfluenceinvestmentreturns.Atthetimeofwriting,theS&PispricedataShillerP/Eof28.5.Thisis69.64%higherthanthehistoricalaverageof16.8suggestingmarketsareatelevatedlevels.U.S.unemploymentfiguresareata30-yearlowsuggestingthatthecurrentbusinesscycleisnearingitspeak.U.S.privatedebt/GDPcurrentlystandsat199.6%andisatitshighestpointsince2009whenthelastfinancialcrisispromptedprivatesectordeleveraging.

Summary Expediaiscompetitivelypositionedgivenadvantagesthataredifficultforcompetitorstoreplicate:(1)astellarportfolioofwell-knownandtrustedtravelbrands,(2)networkeffectscreatedbyapplysupplyanddemand,and(3)switchingcostadvantagescreatedbyitsabilitytoofferrewardsandloyaltyprogramsatscale.

Expediaiswell-positionedinalargeandgrowingglobaltravelmarket.Asmentionedabove,itisoneoftwodominantplayersandoddsarethatitwon’tbedisplacedfromtheduopolyanytimesoon.Furthermore,itisworthnotingthatthefuturelooksbrightforthecompany’sHomeAwaysegment,whichcontinuestogrowalongsideAirbnbinthepopularalternativeaccommodationsmarket.Infact,earlierthisyear,Airbnbwasvaluedat31billiondollarsintheprivatemarket,whichismuchhigherthanExpedia’scurrententerprisevalueofabout$18-19billion.Inshort,Expedia’sshareslookattractivelyvalued.Indeed,basedontheassumptionsusedintheanalysisabove,Expediamayreturnaround9.7%toshareholdersannuallyifpurchasedatthecurrentmarketpriceof$114.20.Assumingthatdiversifiedmarketinvestorsgenerallyrequirea7%annualratereturn(equatingroughlytoa14xearningsmultiple),thenitstandstoreasonthatExpediaistradingatabouta38-39%discount([9.7%-7%]/7%=0.3857)atcurrentprices.

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