Is priceline.com Cruising for Disruption?

priceline.com's (NASDAQ: PCLN  ) agency business, Booking.com, is -- no exaggeration -- the most lucrative business I've ever encountered. It generates huge margins, it's growing very fast, and it has virtually no capital spending requirements. But as long as it's minting money like this, Priceline is bound to attract competition, whether from TripAdvisor (NASDAQ: TRIP  ) , Google (NASDAQ: GOOGL  ) (NASDAQ: GOOG  ) , or someone else. Let's see how well Priceline's equipped to keep those competitors at bay.

Potential disruptors are also partners
In its favor, Priceline is the market leader; it has scale and financial resources, and it's got the most hotels on its platform. Also, it provided $1.8 billion reasons last year for Google and TripAdvisor to play nicely with it. That's how much Priceline spent on online advertising -- an estimated $1.6 billion of which went to Google, at least according to Mark Mahaney, an analyst at RBC Capital Markets.

A smaller chunk went to TripAdvisor, but it was still enough for Priceline to be one of TripAdvisor's largest customers. According to TripAdvisor, Priceline and Expedia accounted for 47% of TripAdvisor's revenue in 2013. And with the overall online travel market growing nicely, with plenty of profits to share, there isn't a burning reason for potential rivals to launch a new competitive battle, at least among incumbents such as Google and TripAdvisor that benefit from the status quo.

That said, companies don't always behave rationally, and competitors will always be interested in stealing such an incredibly lucrative business from Priceline. Google, because of its reach and resources, is probably the biggest near-term threat. Despite being much smaller, TripAdvisor's database of reviews and copious organic traffic could give it an edge in competition with Priceline. And others will certainly pop up over time.

So, what's going to happen? I don't know, and I'd be very skeptical of anyone who claims to know with certainty.

The easy answer and my prediction
There are simply too many variables to make a reliable prediction. Some investors, like Warren Buffett, would put Priceline in the "too hard" pile. That's the easy answer.

If forced to make a prediction, I'd say future competition will not be as fierce as expected by the market. At 18 times forward earnings, with 36% operating margins and 31% earnings growth, Priceline will probably be a market-beater over the next three to five years. The range of future outcomes is very wide (it could be a big winner or a big loser), but on average, I think the probabilities favor beating the market. If Jeffrey Boyd were still CEO, I'd feel a little a bit more comfortable with Priceline. I don't dislike Richard Huston, the current CEO, but he isn't proven yet.

Foolish bottom line
I'd just make sure you're comfortable with the potential risk, and size your position so you can sleep at night. One strategy I might employ is holding Priceline as part of a diversified basket of high upside, but risky stocks. Hopefully, you'll end up with a few big winners that make up for any losers.

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10/22/2014 12:02 PM
PCLN $1125.00 Down -7.97 -0.70%
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