Expedia Leaves the Microsoft Nest (News) November 10, 1999

Expedia Leaves the Microsoft Nest

By Richard McCaffery (TMF Gibson)
November 10, 1999

It's not all bad news for Microsoft (Nasdaq: MSFT) this week.

Expedia (Nasdaq: EXPE), Microsoft's travel services subsidiary, sold 5.2 million shares at $14 apiece after the bell last night, raising about $68 million to grow its online travel services business.

The shares soared past $56 in early trading, giving the company a market value around $2.1 billion. Microsoft owns 85% of the company, so its stake is worth about $1.8 billion.

Think of Expedia as an online travel agent that has created a community of users around the travel industry. In this regard, the company has done a good job.

It went online in October 1996, and as of September 30, 1999, more than 7.5 million users had registered on its website. More than $790 million in airline ticket purchases and hotel and car rental reservations have been made through Expedia so far.

In the travel services category for the month of September, only AOL's (NYSE: AOL) Travel Channel had more unique visitors than Expedia, according to Media Metrix.

Stoked by a healthy economy, travel services is a fast-growing industry. Online transactions in the travel services market are expected to increase from $3.1 billion in 1998 to more than $29 billion in 2003, according to market research firm Forrester Research.

In an evaluation of 34 travel-related sites, Forrester predicted that nine will snag the bulk of future revenues. Expedia came in third in Forrester's ranking, with Yahoo! (Nasdaq: YHOO) grabbing the number one spot. Travelocity, which is owned by Sabre (NYSE: TSG) -- operator of the biggest computerized travel reservation system in the world -- came in number two.

Perhaps the biggest risk for Expedia, as well as its competitors, is that the company doesn't have pricing control over a significant portion of its revenue stream. Why is this so important? Companies with pricing restrictions have to rely largely on volume and efficiency to grow earnings. Take a look at the PC manufacturing industry to get an idea of how difficult life can be.

In Expedia's case, a big chunk of its revenue depends on commissions paid by travel suppliers. As the company explains in its prospectus, Expedia doesn't have written agreements with suppliers so it relies on informal deals for payments -- that's how it's done in the travel industry.

As a result, hotels, airlines, and other suppliers can change commission levels any time they want, a move that would impact Expedia's bottom line. Since 1998, many airlines pay a flat $10 commission for domestic tickets booked online. It's hard to imagine those commissions going up.

It's critical for Expedia to differentiate itself in regard to customer service, and the good news here is that you can go right to its website and kick the tires. Is it fun and easy to navigate? Did you get the hotel price you wanted? How's the content? Get your hands dirty and find out.

The company has differentiated itself from many competitors by letting customers negotiate hotel prices, a la (Nasdaq: PCLN). In fact, Priceline is suing Expedia and Microsoft for allegedly violating its patent. There's no telling how this will work out, but if it doesn't go in Expedia's favor it will lose an edge over competitors.

Expedia also plans to add to its revenue mix by offering new services. Most of its revenues come from airline ticket sales, followed by hotel reservations and car rentals. Expedia plans to offer more involved travel products such as cruises and vacation packages, which should help boost the bottom line.

Investors need to determine how well-positioned Expedia is to build its brand name, establish customer loyalties, and protect its turf. The Microsoft cradle was a cozy place to start, and some of the legacy benefits will continue. For example, Expedia is the exclusive provider of travel services on Microsoft's MSN networks of websites, which had the third highest number of unique visitors for the month of September, behind AOL and Yahoo!

Expedia looks like a company that's in a good position to compete, but the economics of the industry probably aren't compelling enough to make many investors look past its net losses and negative cash flow.

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