Why priceline Came to Rule Them All

Since Motley Fool Stock Advisor opened its pages in 2002, David and Tom Gardner's stock picks have returned an average of 77% each. That compares to 21% for equal positions of the S&P 500.

We're celebrating the newsletter's 10-year anniversary by releasing -- for free -- the original recommendation articles for several of the newsletter's biggest winners. Today we look at priceline.com (Nasdaq: PCLN  ) , which has gained 2,680% since it was picked in the May 2004 issue.

Let's take a look at David's original recommendation in its entirety to see why he picked a stock that had fallen precipitously from its dot-com glory days. Rejoin me at the end of the article for the investing wrap-up.

Below you'll find the write-up exactly as it appeared in the May 2004 issue of Stock Advisor.

David's Top Stock: priceline.com

Ever played the board game Acquire? In its present-day Hasbro incarnation, it's one of my favorites. You lay down tiles to form hotel chain corporations, purchasing shares in them, and then lay additional tiles to grow and ultimately merge them. Whoever has the most money wins. You typically achieve this by getting your smaller chains bought out by the big guys while also managing to own a significant stake in the largest company at game's end. The game ends when either one chain dominates the board, or all existing remaining chains are large enough to be "safe" (11 tiles or greater).

A classic for 40 years now, the game should perhaps have been titled "Acquired" because the message of the game is: Get bought out.

This month, my top pick for you is Priceline.com. It is one of those small- to medium-sized entities that will likely get bought out one day. In the rapidly consolidating industry of online hotel and travel bookings, it may take two years, five years, or 10 years -- I have no hot tip for you here -- but sooner or later Priceline will get gobbled up. In the meantime, I think it's a good small-cap grower that has risen from the graveyard of broken Internet dreams. So whether Priceline eventually gets acquired or indeed closes the game "safe," I believe investors will be rewarded.

Sing It, Bill
Priceline initially got the attention of millions of Americans with its website that allowed you to "Name Your Own Price" to obtain airline tickets, should any vendors offer you one. Sure, you were maybe flying from New York to Detroit via Tallahassee, but you were guaranteed to be paying the low price you specified! (Were customers factoring in the cost of their time?)

And then, of course, you'll likely also remember Star Trek's William Shatner pitching Priceline.com in off-tune ditties, circa 1999. At that time, the stock traded at a market capitalization in the tens of billions, with Priceline taking its "Name Your Own Price" mechanism to not just airline tickets, but gasoline, groceries, and trophy spouses (kidding, sadly, with only one of those...). By the end of 2000, the company had shed almost all $40 billion of its value, kicking around in the few-hundred-million category for almost three years before beginning its rise from the ashes last summer.

A five-year chart of the stock shows you one of the larger ranges you'll encounter: a top price level of $1,000 per share bottoming at $6 per share. PCLN never actually traded near $1,000 -- the company did a 1-for-6 reverse stock split a year ago -- but the percentages are all very real: A loss of 97% of its value in two years, and then later a rise of some 200% since February 2003.

Not Your Father's Priceline
Priceline today continues to let you name your own price, but also features convenience in the form of more traditional travel bookings. Further, the company now owns an Internet site for booking rental cars, and does big business in hotels, as well, offering fuller vacation planning than just the aforementioned flight from New York to Tallahassee to Detroit.

These additional sites really helped this year's first-quarter results, which featured gross profit of $43 million, 31% higher than the $33 million in March '03. That additional $10 million fell through to the bottom line for a profitable quarter, earning 13 cents per share vs. a loss last year.

One thing I like is that only four analysts have earnings estimates for the company. They expect 85 cents per share for the year, and $1.11 next year (31% growth). I like to see such a small number of analysts, as it gives us a chance to get in while there's a lot of room for more institutional coverage. More institutions usually equal more buyers.

Priceline has $278 million in total cash, with $125 million in debt. If you net that out, you have $153 million, which is a pretty healthy percentage of the company's market cap ($874 million as I write this). So for a company just entering a period of steady profitability, you're actually only paying a "cashless" market cap of $721 million, and a forward price-to-earnings ratio of 20 over this year's expected earnings.

I focused on gross profits earlier for a special reason: Historically, Priceline's numbers have been confusing because in its "Name Your Own Price" model it counts the full price of an airline ticket as its revenue, and then nets out all but its fees in cost of revenue. However, with its shift toward more traditional bookings, it would only record the fees it receives as revenues. Thus, the easiest way to see the actual business performance and growth is to follow the growth of gross profits and what falls down to the bottom line from there. (We have a good article about this on Fool.com titled "Priceline's New Math," by Seth Jayson, March 26, 2004. I recommend it to all you armchair researchers.)

Profiting Two Ways
I typically recommend the No. 1 or No. 2 player in most industries, which makes Priceline unusual for me. It gets stiff competition from Orbitz, Travelocity (owned by Sabre Holdings), and Expedia (of InterActiveCorp, which also owns Hotwire.com, Hotels.com, etc.). And it is admittedly not doing anything particularly special beyond its profitable "Name Your Own Price" operation.

That's why I view PCLN as a stock sitting squarely on the Acquire game board, growing nicely but also likely a juicy target for acquisition at some point. That usually comes with a nice premium for existing investors, whom I expect to be rewarded anyway because the company is a strong performer in a growing industry. Perhaps Priceline will one day be in the position of naming its own price.

In the meantime, where's that William Shatner album?

-- David Gardner, May 2004

Investing lessons
In 2004, David recognized that priceline was a great acquisition candidate, and it's a wonder it didn't happen. After gaining over 2,600% in value, priceline's $33 billion market cap is now larger than any other player in the industry -- greater than Expedia (Nasdaq: EXPE  ) , Orbitz, IAC/InterActiveCorp (Nasdaq: IACI  ) , Ctrip.com (Nasdaq: CTRP  ) , and Travelzoo (Nasdaq: TZOO  ) combined.

What David really nailed was the inefficiency of a tiny number of analysts providing estimates. The four were predicting around 31% annual EPS growth, and the stock traded at 20 times those estimates. Instead, here's priceline's actual EPS growth for the next few years: 181%, 455%, (-60%), 81%, 23%, and 164%.

Fool analyst Rex Moore tweets but is not a twerp. He runs a real-money portfolio based on his screens. He owns no companies mentioned here. The Motley Fool owns shares of Priceline.com and Ctrip.com International. Motley Fool newsletter services have recommended buying shares of Travelzoo, Ctrip.com International, and Priceline.com. The Motley Fool has a disclosure policy.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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