The year surely got off on the wrong foot for travel site
Expedia.com (Nasdaq: EXPE)
. On New Year's Day,
, parent of American Airlines, announced it was pulling its flight
information from Expedia's listing service. AMR's move was just the
latest twist in an airline vs. website battle that started a few
months earlier when AMR announced plans to terminate its
relationship with Expedia rival
. Coming to its rival's defense (for the sake of the entire
industry), Expedia ultimately pushed AMR's flight listings to the
end of the queue, leading AMR to take that retaliatory move on New
Two months later, AMR's aggressive stance looks increasingly
unwise. A diminished presence on those sites has led the carrier to
lag behind rivals in terms of bookings in what has otherwise been a
robust period for most of AMR's rivals. Someone is going to blink
in this battle, and it increasingly looks as if Expedia will emerge
victorious. But the damage is done.Shares of Expedia are off
roughly 25% in the past three months, while the S&P 500 is up
about 3%. That contrast should reverse course in coming quarters,
and Expedia looks like a solid rebound candidate.
Lots of cash now, more later
Until the recent rough patch, Expedia had emerged as one of the
cleanest business models in the leisure space. EBITDA margins
typically approach 30%,return on equity (ROE) is always in the
upper teens andfree cash flow (
) now tops $500 million annually. That strong FCF has put more than
$1.2 billion in cash on Expedia'sbalance sheet (or $4.27 a share).
Management is doing three things with all that cash. First, it's
buying back even more stock (the share count has dropped 20% in
five years and could drop another 10% this year). Second, the
company issued its firstdividend in 2010, which may be sharply
hiked in 2011 (though thecurrent yield is still too paltry to
consider). Lastly, the company is stepping on the gas in terms of
It's that last factor that's also been a source of concern for
investors, beyond the spat with AMR. On the fourth-quarter
conference call, management announced plans to boost spending on
growth initiatives this year, which will dampenprofit growth in the
near-term. Analysts have lowered theirprofit forecasts for 2011 by
about 10% to account for that spending.
For my money, stepping up investments while a company is in
growth-mode makes clear sense. The short-term hit to profits sets
the stage for higher profits down the road. Indeed, analysts
predict that Expedia's
growth will re-accelerate in 2012.
A large shadow
To be sure,
Priceline.com (Nasdaq: PCLN)
remains as the industry darling. Its revenue is growing faster as
it overtakes Expedia's dominant position in international travel.
Priceline's $4 billion in projected revenue in 2011 will allow it
to overtake Expedia for the first time (which is expected to have
$3.7 billion in revenue in 2011).
But are investors getting carried away with their love of
Priceline.com and their current disdain for Expedia.com? The
numbers tell the story. Priceline is roughly three times as
expensive on an
basis. That disparity also exists when you measure these two stocks
in terms of
free cash flow
. Indeed Expedia's FCF
of nearly 13% is almost unheard-of for companies that are still in
Action to Take -->
Simply being cheap is not reason enough to buy
. Instead, you need tospot catalysts that will move Expedia back
into favor. And they surely exist.
For starters, analysts increasingly believe AMR will need to
reverse course to stem
erosion. The carrier would prefer to deal more directly with
customers or at least with closely-affiliated travel agents. But
sites such as Expedia and Orbitz are here to stay, and AMR is
learning that you avoid them at your own peril. Citigroup predicts
AMR and Expedia will make peace in the second half of this year,
adding that any such deal is not yet incorporated into profit
Secondly, investors will start to see that Expedia is developing a
powerful ancillary revenue stream in terms of advertising. Ad sales
hit $485 million in 2010, and they should top $600 million this
year. This revenue comes with especially high margins, which may
push Expedia's gross margins above 80% in 2011.
Third, the newly-cheaper shares imply that Expedia can buy back a
larger amount of shares under its current authorization. Any
further share price weakness will shrink the share count that much
Lastly, Expedia should benefit from a "re-set bar," which means
that analysts have taken their profit forecasts for 2011 and 2012
down to the point where Expedia should deliver estimate-topping
results, as has usually been the case in recent years -- except for
the most recent quarter.
It's been a tough winter for Expedia, but the company should
benefit from its stance as the industry's underdog. You'd do well
to consider this bounce-back candidate for your own portfolio.
-- David Sterman
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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