The stock price of The Priceline Group (NASDAQ: PCLN ) has rocketed up over 63% in the last year, reflecting the company's massive growth and terrific prospects. However, it has declined by over 15% since March. While Expedia (NASDAQ: EXPE ) dominates the U.S. market, Priceline has its sights set on international expansion.
Priceline's ability to expand rapidly without significant capital expenditures ensures that the company will continue to grow profitably for years to come. As a result, the recent pullback may be a buying opportunity for growth investors who missed the run-up.
A powerful model
Priceline's large network of hotels and its agency model enable it to grow earnings at a high rate relative to the capital invested in the business. Booking.com, which generates the majority of Priceline's revenue, acts as a referral service for hotels and other third-party travel services. It provides a convenient way for travelers to search for and book travel accommodations, and charges a referral fee to the third-party providers.
The best part about Booking.com is that the business does not require meaningful investments to expand. Whereas manufacturers have to build new factories to expand production and retailers have to invest in working capital to open new locations, Booking.com simply calls hotels to arrange referral deals and spends money on advertising to draw more customers to the website.
Moreover, it does not cost Booking.com anything to provide the service. While manufacturers buy raw materials and retailers buy inventory, Booking.com has no cost of goods sold. This means that all of the revenue from each additional customer who books travel accommodations through Booking.com falls straight toward the bottom line. The only costs are those to maintain the website and advertising expenses to draw in more customers. This is a powerful business model.
There's growth overseas
Booking.com's "referral" strategy is called an agency model. Priceline.com also utilizes the agency model. The company's overall agency revenue grew 40.3% in 2013 to $4.4 billion -- 65% of overall revenue. This is the key growth driver for the business and is the factor that will determine whether investors get a good or poor return on investment.
Priceline has a long runway for growth, but it won't come from the U.S. Although Priceline also operates within the U.S., Expedia has a much tighter grip on the domestic market; Expedia derives 53% of its revenue from the U.S. Since the many travel booking services already serve the U.S. market, it is unlikely that Priceline has room to significantly expand its presence in the country, particularly with strong competition from Expedia.
Fortunately, Priceline is in a much better position outside the U.S. Already, 94% of the company's operating income derives from international sources. International markets are less saturated than the U.S. market, which makes them prime sources of growth.
Since Booking.com already lists hundreds of thousands of properties in over 190 countries, customers and service-providers are more willing to do business with Booking.com than a smaller website. As a result, Priceline is set to capture a large portion of the industry's growth over the next decade.
How pricey is Priceline?
There is little doubt that Priceline will grow at a high rate over the next several years. Exactly how quickly it grows will determine whether or not the stock is a good buy. The stock is priced at 27 times free cash flow. After subtracting net cash, the stock trades at 25 times free cash flow. Earnings and free cash flow are growing rapidly; in 2013, Priceline's earnings per share grew 30.5%.
Although the company is unlikely to sustain the same growth in the years ahead, 20% annual growth for many more years is a real possibility. At that rate, the company would earn $62.40 per share in 2016 and free cash flow would likely be even higher. Today, investors can buy Priceline at 18.5 times that projection of 2016 earnings to invest in a company that will keep growing at a double-digit pace for a long time. That appears to be a good deal -- but only if it continues its high rate of growth.
Should you buy?
Priceline has a powerful business model that enables it to expand with hardly any additional capital. The only major investment required is advertising, which can be reduced as the company matures. Although Expedia's strong presence in the U.S. market makes it difficult for Priceline to grow domestically, international markets provide a long runway for growth. Since Priceline's stock is not priced at a stratospheric multiple like those of many growth companies, it could be a good buy for investors who believe that the company's growth will continue on schedule for many more years.
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