Expedia's (Nasdaq: EXPE) fourth-quarter results were not terrible, but were disappointing. With the economic recovery and strength shown by some of its competitors, especially priceline.com (Nasdaq: PCLN), investors expected much more. Expedia was unable to turn increasing investment and marketing spend into meaningful demand as booking growth decelerated from 20% in the first quarter, 15% in the second quarter, and 16% in the third quarter down to 13% in the most recent quarter. Revenues from the quarter rose 16% over a year ago, but net income fell from $102.2 million to only $71.3 million.
While the results were certainly not good, it took more than an underwhelming quarter from Expedia to drive down shares nearly 20% on Friday. Sentiment and investor confidence in the company has been shaken by its recent spat with AMR's (NYSE: AMR) American Airlines. The feud has led to the removal of American Airlines' flight details from Expedia as well as Orbitz's (NYSE: OWW) flight databases, which is one of the reasons both stocks have been significantly lagging the market even before Expedia's earnings blow-up on Thursday. However, American Airlines ticketing business only contributed about 1% to Expedia's revenue and total airline ticketing is only about 12% of its total business, so I believe it's silly for investors to focus on this issue.
Airline troubles are manageable
Still, the airline industry's recent mini-revival and attempts to bring more travel booking back to its own sites can't be ignored entirely. The airlines have been attempting to boost profits by charging for add-ons like extra leg room, seat preference, and faster check-in lines which have proven difficult to implement through the online travel agency sites. American insists that Expedia use its proprietary ticketing system on the site to hammer out this problem, though other airlines like US Airways (NYSE: LCC) have already worked out deals to allow them to charge for such add-ons without interrupting Expedia's platform. Until the airlines start selling each other's tickets, the online travel agencies remain an important selling tool, and value-add for customers. As Expedia CEO Dara Khosrowshahi said on the conference call, "I think if American is willing to work with us the way that 300 other airliners are, we'd certainly be happy to work with them."
Google's threat
While the airline issues are manageable, I'm more worried about the threat to what I believe is one of Expedia's real growth opportunities. As Expedia's leisure travel business has remained relatively flat since 2007, and its corporate travel service Egencia finally began posting gains in 2010, TripAdvisor has been a constant grower for the company since late 2008. Revenue from the travel search, review, and social networking site has posted especially strong gains last year, through both organic growth and some astute acquisitions. TripAdvisor's extremely strong brand, higher margin business, and tie-in with other Expedia sites, is an undervalued asset that differentiates Expedia from many of its competitors. It also has a strong international presence, and is growing rapidly in China with travel sites Daodao.com and Kuxun.cn. However, Expedia is now facing significant pressure from a real Internet giant.
Many are focused on how Google's acquisition of travel data specialist ITA Software will affect the entire online travel space. I believe collectively the industry will adapt to; and it's important to note the deal still does face many regulatory hurdles. Though I am concerned with the search giants attempt to minimize TripAdvisor through its Google Places initiative. Expedia itself worried that Google has manipulated it search algorithms to favor its own Google Places pages over third-party websites. The statistics show that these worries may just be justified. Since June upstream traffic directed to TripAdvisor from Google has declined, while during the same period traffic directed from Facebook actually increased by 30%. It is hard to determine just how much of the decline stems from Google directing traffic to its own site, but one must assume Expedia would start a public battle with Google if it wasn't significant.
Value in numbers
With over 40 million reviews, TripAdvisor has cold hard consumer data that neither Google Places nor any other competitor can match, but with Google pushing organic search results further and further down the page, this competitive advantage could diminish fast. While it is still difficult to determine just how much of an effect this will have on TripAdvisor's business model, shares of Expedia are priced as if it will be significant. At an enterprise value/EBITDA of 7.1, the stock is significantly cheaper than competitors like priceline.com at 28.3 and Travelzoo (Nasdaq: TZOO), which trades at 29.1. This is certainly a very compelling valuation if you believe the Google threat is overblown, but I'm not so sure it is.
