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Over the last year, Expedia (NASDAQ: EXPE ) has been a very fickle company, at times showing the greatness of Priceline.com (NASDAQ: PCLN ) and then often looking more like Orbitz (NYSE: OWW ) . Despite this fact, shares are currently trading at new all-time highs, which makes me wonder whether investors should finally feel confident to hold Expedia long term?
An inconsistent past
Orbitz had the potential to be a great online travel company: It had a strong platform, a loyal user base, and initial growth.
Instead, the company has been trapped in a rut, unable to really breakout and produce the same level of growth that we've come to expect with the likes of Priceline.com. Essentially, the company made bad investments – has a return on assets of only 3.5% -- that have hurt its profitability.
Specifically, Orbitz has operating margins of only 7.8%; and now, with nearly $500 million in debt and an accumulated deficit of more than $1 billion, the company is unable to take large calculated risks or produce the consistent growth that so many investors expect.
In many ways, Expedia has become very much like Orbitz.
Expedia has more debt at $1.25 billion, and has made just as many bad investments, which is why its return on assets is just 4.3%. As a result, Expedia's fundamental performance has been inconsistent over the last year.
What has Priceline.com done differently?
If you look at the valuations of Priceline.com and Expedia – Priceline.com's market cap is nearly 6.5 times larger – you might not realize that Priceline.com is only 35% larger based on annual revenue.
Clearly, Priceline.com has been awarded a valuation premium, which is well-deserved.
Over the years, Priceline.com has made tremendous investments in emerging markets and with acquisitions like Booking.com and Kayak. This is evident based on its return on assets of 17.36%, which then translates into an operating margin of more than 35%.
To put this in perspective, Priceline.com's operating margin is more than triple that of Expedia. And given the fact that both operate in the same industry with a near equal presence in emerging markets, this level of efficiency on behalf of Priceline.com is staggering.
Still, with Expedia being so large the opportunity for improvements is present. Expedia just needs to make solid investments, continue to grow, and improve its margins consistently.
What does this mean for Expedia?
From an investment perspective the upside is absolutely enormous, which can be seen in the disconnect between valuation and the fundamentals of it and Priceline.com. The problem is that if Expedia is ever going to trade at a multiple that mirrors Priceline.com it has to become fundamentally consistent, which is where the risk comes into play.
However, Expedia's most recent quarter might signal that the company has turned a corner. Specifically, Expedia grew revenue by 18% year-over-year including a 21% boost in bookings, both of which were better than the prior quarter. This came in a quarter when Expedia's visibility in Google search reportedly fell significantly, up to 25% according to some reports, a problem that has since been resolved.
As a result, Expedia showed great strength in emerging markets to help drive its 18% growth. In particular, Trivago, which was acquired by Expedia early last year, grew an incredible 85% year-over-year. Furthermore, Expedia claims that Trivago's growth was responsible for four percentage points of its 18% total growth, meaning that without Trivago Expedia's total revenue would've grown at a less impressive 14% clip.
Now, while some might view Trivago's impact on Expedia's topline as negative, investors must remember that this represents a successful investment on behalf of Expedia, which is something Priceline.com has been doing for the better part of the last decade.
As a result, Expedia achieved net income growth, as profits rose 41% year-over-year, showing a significant boost in margins.
Right now, even at new highs Expedia is cheap and has the potential to trade considerably higher if the company can continue to grow and operate efficiently.
Granted, Expedia is not growing at the same level as Priceline.com, but with Trivago it does seem that Expedia has a real gem on its hands. As a result, as Trivago continues to grow and become a larger piece of the Expedia pie, the company's total return on assets should rise, which in turn will drive margins, increase profitability, and produce revenue growth.
Overall, the impact of Trivago points to a very bullish year for Expedia: The company simply needs to stay in the double digit growth rate range, let Trivago do the rest, and then its stock will continue to trend higher.
Hence, you might not be able to fully trust Expedia yet, but you can give it the benefit of the doubt, at least for now.
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