Expedia Soars After Solid Q2

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Expedia Inc. (EXPE) reported another good quarter, with earnings topping the Zacks Consensus Estimate by 12 cents, or 16.9% (the Zacks ESP, or expected surprise prediction was 11.3%). While expenses continued to increase, revenue growth outdid the impact, as well as the impact of a higher tax rate.  

Investors bought enthusiastically, sending shares up 14.6% in after-hours trading (following the 3.3% increase during the day).

Revenue

Revenue for the quarter was $1.04 billion, up 27.4% sequentially and 13.8% year over year. Management stated that the VIA acquisition contributed 2 percentage points of revenue growth. Currency was even more negative than expected, without which revenue growth would have been stronger, and bookings growth and 3 percentage points of adjusted EBITDA growth.

Revenue by Segment

Leisure customers remained the significantly larger contributors to in the last quarter, generating around 93% of revenue. Corporate customers (Egencia) accounted for the balance. The two segments grew 26.2% and 43.4%, respectively from the previous quarter and were up 11.3% and 61.7%, respectively from the year-ago quarter.

With TripAdvisor gone, Expedia is almost totally dependent on the Leisure segment (although it is beefing up the Egencia segment with acquisitions). The Leisure business continues to be driven by hotel revenue, since rising airfares are impacting ticket revenues.

Room nights continued to increase double-digits slightly offset by a 1% drop in the ADR, indicating higher demand and Expedia’s broadening reach. Room night growth was even higher including its JV with Air Asia.

However, the revenue per room night declined, impacted by higher mix of chain hotels. Overall, the growth in Asia (much lower ADRs and revenue per room night) remains much stronger than other regions and this will likely remain a negative impact on hotel margins, while driving up volumes in the next few quarters.

While the leisure segment is the largest and most important for Expedia, it is clear that the company is gaining ground in the Egencia (corporate) segment as well. Corporate spending on travel continues to pick up, despite the rising airfares that were negative to Expedia’s leisure business in the last quarter. Egencia has increased at a double-digit year-over-year clip in each of the last eleven quarters and growth rates appear sustainable.

Revenue by Channel

Around 76% of total revenue was generated through the merchant business (direct sales), another 21% came through the agency model (where Expedia operates as an agent of the supplier) and roughly 3% came from Advertising and Media. The three channels grew 20.9%, 30.5% and 3.2%, respectively in the last quarter. Growth from the year-ago quarter was 10.0%, 14.9% and 10.3%, respectively.

Revenue by Product Line

Hotel and Air, the two main product lines grew 16% and 8%, respectively from the year-ago quarter. The increase in Hotel revenue came from a 22% increase in room nights and a -1% decline in the average daily rate (“ADR”). Revenue per night dropped 5%.

The results are mix-driven. The increase in ticket revenue was attributable to a 3% increase in ticket volumes even as airfare growth increased 5%. The revenue per ticket dropped 11%.

Revenue by Geography

Around 58% of Expedia’s quarterly revenue was generated domestically, with the remaining 42% coming from international sources. The domestic business grew 22.4% sequentially and 14.3% from a year ago. The international business grew 35.1% sequentially and 13.1% from last year.

Hotels.com did extremely well in the U.S., was impacted by softness in Southern Europe, but did well in Asia. Additionally, the JV with Air Asia generated solid growth in Asia.

Bookings and Revenue Margin

Gross bookings were $8.96 billion in the last quarter, up 6.4% sequentially and 12.6% year over year. The revenue margin was 11.6%, up 191 bps sequentially and 13 bps from a year-ago indicating higher conversions. Overall, conversions improved across segments, geographies and channels and were in line with seasonality.

International conversions were a shade better than domestic and Leisure conversions were higher than Egencia, although Egencia was up pretty strongly from last year. Both agency and merchant channels saw higher conversions.

Margins

The pro forma gross margin for the quarter was 77.9%, up 242 bps sequentially and down 68 bps year over year. Higher costs for credit card processing (due to merchant bookings growth) and higher personnel expenses due to increased headcount, additional costs related to VIA were only partially offset by lower debit card fees credit card rebates.

The number of transactions increased from 20.2 million in the year-ago quarter to 23.1 million in the last quarter. However, gross profit dollars continued to grow from $717.8 million in the year-ago quarter to $810.2 million in the last quarter.

The operating expenses of $643.8 million were up 14.0% sequentially and 13.8% from last year. It appears that some costs were pushed into the third quarter, without which expenses would have been up more significantly.

As a result, the operating margin came in at 16.0%, up from 6.3% in the previous quarter and down slightly from 16.7% a year ago. All expenses declined sequentially as a percentage of sales, with S&M declining the most, followed by cost of sales, technology and content and G&A in that order. S&M also declined from the year-ago quarter (pushed into the third quarter), with all other expenses increasing.

Adjusted EBITDA as reported by the company was $222.9 million, up 119% sequentially and 18% from the year-ago quarter.

Net Income

On a pro forma basis, Expedia generated a net income of $114.5 million, or a 11.0% net income margin compared to $24.7 million, or 3.0% in the previous quarter and $95.3 million or 10.4% net income margin in the same quarter last year. The fully diluted pro forma earnings per share (EPS) were 83 cents, compared to 18 cents in the March 2012 quarter and 69 cents in the comparable prior-year quarter.

Our pro forma estimate excludes intangibles amortization charges, legal reserves and occupancy tax assessments on a tax-adjusted basis but includes deferred stock compensation. Our pro forma calculations may differ from management’s presentation due to the inclusion/exclusion of some items that were not considered by management.

Including the above special items, as well as discontinued operations and non controlling interests, the GAAP net income available for Expedia shareholders was $105.2 million ($0.76 a share) compared to loss of $3.3 million ($0.02 a share) in the previous quarter and income of $140.4 million ($1.01 a share) in the year-ago quarter.

Balance Sheet

Cash and short term investments totaled $2.39 billion at quarter-end, up $395.8 million during the quarter. The net cash position of $1.14 billion was significantly higher than the $748.4 million in net cash going into the quarter.

Including long-term liabilities, the debt to total capital ratio was 43.4%, still at manageable levels. Days sales outstanding (DSOs) went from 46 to 45. We note that around 40% the assets is goodwill (not a real asset).

Expedia generated $552.8 million of cash from operations in the last quarter. It spent $66.4 million on capex, $199.3 million on acquisitions, $12.2 million on dividends and $99.5 million on share repurchases.

Our Take

Expedia topped both revenue and earnings expectations in the last quarter, helped by a stronger travel market all over the world, a contribution from VIA and the push-out of some costs into the next quarter. Online travel booking is particularly buoyant because of the shift from offline channels.

The opportunity in the Asia/Pacific region is significant and is likely to remain one of the strongest drivers of the company’s business over the next few quarters, particularly since online penetration in many Asia/Pacific markets remains relatively low.

The company has responded by steadily increasing its hotel inventory and entering into strategic relationships, such as the one with Air Asia. An improved technology platform should lead to continued improvement in conversion rates going forward.

The increasing presence in Asia does have a downside with respect to margins given the lower ADRs. While it is true that technology upgrades will negatively impact margins in the near term, the investments could only be considered fruitful if they result in better conversions.

Over the long term, we consider this investment a positive for investors, since it has the potential to generate stronger revenue and profits going forward. However, the near-term impact is likely to be negative.

Of course, the company will continue to face challenges from players like Priceline.com (PCLN), Orbitz Worldwide (OWW) and Travelocity, as well as a growing number of local Chinese players that could make expansion in the fast-growing Chinese market difficult.

Additionally, Google Inc’s (GOOG) venture into the travel market is expected to increase costs for Expedia. The TripAdvisor spin-off is a positive in this respect, although Expedia is losing the advertising hedge it has enjoyed in the past. Competition aside, Expedia and other online travel agents continue to fight the incidence and collection of occupancy taxes.

We have a Zacks Rank of #2 on Expedia shares, which translates to a short term Buy rating. We remain Neutral on a long-term basis.

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