Expedia's Costs Rise, Shares Fall

Zacks

Expedia Inc. (EXPE) reported first-quarter earnings that were 27 cents short of the Zacks Consensus Estimate despite strong revenue that came in 5.3% higher. As a result, shares lost 5.3% in after-hours trading, more than offsetting the 1.2% gained during the day.

Revenue

Revenue for the quarter was $1.01 billion, up 3.8% sequentially and 24.0% year over year. Management stated that the Hotwire brand was impacted by the domestic car business (fleet constraints and attempts to drive up pricing), a challenging opaque business that is the natural result of a stronger economy and a similar opaque product launched by a close competitor.

Revenue by Segment

Leisure customers remained the significantly larger contributors in the last quarter, generating around 91% of revenue. Corporate customers (Egencia) accounted for the balance. The two segments grew 3.8% and 4.7%, respectively from the previous quarter and were up 20.9% and 67.9%, 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). Expedia continued to benefit from the acquisitions of VIA Travel that closed in the second quarter of 2012 and trivago, which closed in the beginning of March 2013. VIA’s operations are mostly in Northern Europe, which has done much better than the South in recent times.

Revenue by Channel

Around 72% of total revenue was generated through the merchant business (direct sales), another 23% 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 were up 0.4%, 10.4% and 39.4%, respectively from the Dec quarter of 2012. Growth from the year-ago quarter was 21.6%, 28.6% and 48.4%, respectively.

Revenue by Geography

Around 55% of Expedia’s quarterly revenue was generated domestically, with the remaining 45% coming from international sources. The domestic business grew 9.2% sequentially and 13.6% from a year ago. The international business fell 2.2% sequentially while increasing 39.7% from last year.

Revenue by Product Line

Hotel and Air, the two main product lines grew 24% and 14% respectively from the year-ago quarter. The increase in Hotel revenue came from a 28% increase in room nights supported by a flat average daily rate (“ADR”). Revenue per night dropped 3%. In the last quarter, international room night growth of 43% was nearly three times the domestic room night growth of 15%.

Mix was clearly negative, as 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. ADR are also lower in Europe than in the U.S. Expedia believes that the added scale of the lower-margin business would more than make up for the negative mix impact going forward.

The increase in ticket revenue was attributable to a 9% increase in ticket volumes and flat airfare growth. Revenue per ticket increased 5%.

Bookings and Revenue Margin

Gross bookings were $9.78 billion in the last quarter, up 30.0% sequentially and increasing 16.2% year over year. The revenue margin was 10.4%, down 260 bps sequentially but up 65 bps from a year ago indicating higher conversions on a year-over-year basis due to strength across segments, channels and geographies.

Conversions in both the domestic and international businesses followed the same trend. Leisure conversions were better than corporate and merchant conversions better than agency in the last quarter.

Margins

The pro forma gross margin for the quarter was 75.2%, down 166 bps sequentially and up 24 bps year over year. The growing mix of international business is negatively impacting the gross margin. Higher costs for credit card processing (due to merchant bookings growth), higher headcount and other costs related to VIA and increased headcount costs to support other operations across the world also contributed. However, higher volumes resulted in a 1.6% sequential and 23.6% year-over-year increase in gross profit dollars.

The operating expenses of $783.5 million were up 25.1% sequentially and 38.8% from last year. This drove the operating margin to -2.1%, down from 12.7% in the previous quarter and 6.3% a year ago. All expenses increased both sequentially and year over year.

Adjusted EBITDA as reported by the company was $105.1 million, down 43% sequentially and up 3% from the year-ago quarter.

Net Income

On a pro forma basis, Expedia generated a net loss of $21.2 million, or a 2.1% net loss margin compared to profit of $77.9 million, or 8.0% in the previous quarter and $24.7 million 3.0% net income margin in the same quarter last year. The pro forma loss per share was $0.16, compared to profit of $0.55 cents in the Dec 2012 quarter and $0.18 cents in the Mar quarter of 2012.

Our pro forma estimate excludes intangibles amortization charges, legal reserves and other items 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 non controlling interests, the GAAP net loss attributable to Expedia shareholders was $104.2 million ($0.77 a share) compared to income of $6.7 million ($0.05 a share) in the previous quarter and loss of $3.3 million ($0.02 a share) in the year-ago quarter.

Balance Sheet

Cash and short term investments totaled $2.09 billion at quarter-end, up $151.0 million during the quarter. The net cash position of $839.8 million was up from $688.8 million in net cash going into the quarter. Including long term liabilities, the debt to total capital ratio was 42.0%, still at manageable levels. Days sales outstanding (DSOs) went from 42 to 43. We note that over 40% of assets is goodwill (not a real asset).

In the last quarter, Expedia generated $881.1 million of cash from operations. It spent $87.2 million on capex, $540.5 million on acquisitions, $18.0 million on dividends and $117.7 million on share repurchases.

Our Take

Expedia topped our revenue expectations in the last quarter, helped by a stronger travel market all over the world, contributions from VIA and trivago, and strategic expansion in Asia. 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 this, as well as technology upgrades will negatively impact margins in the near term, we consider the investment a positive, since Asia is one of the fastest-growing regions that should give Expedia the scale required to generate higher profits over the long term.

Expedia has also made some important acquisitions that are driving up its costs. This will negatively impact its profits until sufficient volumes are generated.

Of course, the company will continue to face challenges from players like Priceline.com (PCLN), Orbitz Worldwide (OWW), Travelocity and Ctrip.com international Ltd (CTRP) as well as a growing number of other local Chinese players that could make expansion in the fast-growing Chinese market difficult. Competition aside, Expedia and other online travel agents continue to fight the incidence and collection of occupancy taxes.

Expedia shares carry a Zacks Rank #3 (Hold).

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