Shares of Priceline Group (NASDAQ:BKNG) took a nose dive after the company reported its third-quarter earnings. While the results came in better than expected, management's fourth-quarter outlook proved disappointing.
But the share price quickly rebounded to the same level it had reached before the third-quarter report. That's a sign of a strong underlying company -- one worth investors' attention. Priceline is well positioned to expand its leadership in the online travel agency market over the next few years, making it a potential gold mine for growth investors.
The network effect in full force
Priceline has more hotel listings than any of its competitors, particularly in developed markets like Europe. The company's Booking.com platform has over 657,000 hotels and 816,000 vacation rentals listed on its website as of the end of September 2017. Total property listings are up about 41% year over year. That compares extremely favorably to second-place Expedia (NASDAQ:EXPE), which has about 405,000 hotel listings and 95,000 vacation rentals on its flagship Expedia.com platform.
Priceline's lead in Europe is extremely insulated. The majority of hotels in the region are small boutique hotels with limited advertising budgets, making them reliant on online travel agency partnerships to increase bookings. What's more, their small size prevents many from implementing the necessary staffing to manage bookings across multiple platforms and maintain multiple relationships with OTAs.
Since Priceline has more hotel listings, travelers are more likely to find what they're looking for on its websites. That leads to greater booking conversions and customer loyalty, which in turn makes it more attractive to its hotel partners, creating a virtuous cycle. Room nights booked on Priceline's properties increased 22% through the first nine months of 2017 versus 17% for Expedia, pointing to this meaningful advantage.
Spending for long-term growth
One reason for the poor fourth-quarter guidance from Priceline is that it's pulling back on performance advertising -- i.e., advertising on other websites that leads a customer to book on Priceline properties. As demand for those ad placements increased, management felt the return on investment had diminished to the point where it was no longer worth it.
Instead, the company is investing in brand advertising like television commercials. That will cause a short-term drop in conversions as Priceline sees less traffic from performance ads and starts relying on visitors coming to its websites directly based on brand recognition and loyalty.
Management said it expects to run Booking.com television advertisements in 30 countries by the end of 2017, up from 12 in 2016. While it wouldn't give much more detail, management did say it expects the increase in TV ad spending to negatively affect its profit margins.
Brand advertising takes longer to affect sales, but the long-term benefits are far greater than a one-time booking from a performance advertisement. So, while management may be giving up some sales in the short term, it stands to benefit in the long term. Investors with a long-term horizon can benefit from this strategic shift as well.
A buying opportunity
Even though shares have already recovered from their dip after the third-quarter report, investors interested in a long-term growth story could still do well with shares of Priceline.
The company benefits from a strong network effect, driving more and more customers and hoteliers to its platforms in a virtuous cycle. We've seen other digital advertising and e-commerce properties (of which Priceline is sort of a mix) like Facebook and Amazon benefit from similar network effects.
Meanwhile, management's long-term focus is essential for a growth stock, as it should eventually exhibit greater leverage for its advertising and IT spending as it continues to acquire scale. As such, Priceline's growth story may just be getting started.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Amazon and Priceline Group. The Motley Fool owns shares of and recommends Amazon, Facebook, and Priceline Group. The Motley Fool recommends Expedia. The Motley Fool has a disclosure policy.