Priceline Group (NASDAQ:BKNG) and Expedia (NASDAQ:EXPE) are the two leading players in online travel agencies, an industry offering enormous potential for growth in the years ahead. Expedia was the clear winner last year. The stock is up by an impressive 27% over the past 12 months, versus a much more modest gain of only 5% for Priceline in the same period. However, past performance is only a prologue to future returns. Which one is a better buy going forward: Priceline or Expedia?
Conquering the world
The online travel industry is going through a consolidation process, as both Priceline and Expedia have made important acquisitions over the past several years. Big purchases from Priceline include names such as Agoda.com, Kayak, Rentalcars.com, and OpenTable, while Expedia has purchased Trivago, Travelocity, Orbitz, and HomeAway, among others.
Consolidation is a major positive for investors. Size is an important advantage in the industry. Both travelers and industry operators want to go with to the platforms offering more and better deals, so a bigger platform is generally a more valuable one. Besides, consolidation keeps pricing competition at bay, allowing both Priceline and Expedia to operate with juicy profit margins.
Interestingly, Priceline announced in October that it will be joining TripAdvisor (NASDAQ:TRIP) in its instant-booking platform. TripAdvisor is at the same time a valuable partner and a competitor for online travel agencies. TripAdvisor drives plenty of traffic to Priceline and Expedia in exchange for referral fees through its meta-search engine, but it also acts as an alternative to Priceline and Expedia services with its instant-booking platform. Now that Priceline has decided to join forces with TripAdvisor, this could have important implications from a competitive perspective going forward.
International presence and currency impact
The two companies are quite different in terms of geographic exposure. Priceline has a bigger presence in international markets, while Expedia is stronger in the United States. According to financial reports for the third quarter of 2015, Priceline makes 88.4% of gross bookings in global markets, while Expedia makes only 38% of its bookings overseas.
This international leadership is a big plus for Priceline in the long term, as it offers compelling opportunities for growth in under-penetrated markets. On a short-term basis, however, most global currencies are depreciating versus the U.S. dollar, and this is hurting Priceline's financial performance when expressed in U.S dollar terms.
Priceline reported $14.8 billion in gross bookings during the third quarter of 2015, a 7% year-over-year increase. On a constant currency basis, however, gross bookings increased by a much stronger 22%, so currency headwinds are having a considerable impact on Priceline's numbers.
Expedia, on the other hand, brought in $15.4 billion in gross bookings during the quarter. The year-over-year increase in gross bookings was 21% in U.S. dollars and 26% in constant currency, so Expedia isn't being hurt by currency depreciation to the same degree as Priceline.
Priceline's superior business model
One considerable advantage Priceline has over Expedia is that the company does most of its business via the agency business model, acting as an intermediary between buyers and sellers as opposed to buying inventory and then reselling it to customers. This approach allows Priceline to produce amazing profitability. The company retains nearly 35% of revenue as operating profit.
Expedia, on the other hand, is more exposed to inventory risk, so profit margins are more volatile and significantly smaller, in the neighborhood of 17% of sales during the third quarter.
Both Priceline and Expedia have materially increased their spending in marketing and advertising over the past several quarters, and it makes sense to expect increased competitive pressure among the online travel leaders in the future. Under such a scenario, Priceline's superior profitability could be a crucial advantage, allowing the company to allocate more financial resources to marketing and advertising.
Priceline or Expedia?
Both companies are reasonably priced. Priceline carries a forward price-to-earnings ratio around 16.6, while Expedia has a forward P/E in the neighborhood of 18.3. Considering valuation, financial performance, and growth potential in online travel, both Priceline and Expedia look like solid investment alternatives.
In fact, buying the two main players in the industry could be a smart choice, since you get to profit from strong demand for online travel services while diversifying competitive risk away.
Leaving this possibility aside, economic conditions are currently more favorable to Expedia because of a strong U.S. dollar. However, Priceline's global leadership and superior business model are major advantages from a long-term point of view. On a multi-year time horizon, Priceline could deliver higher returns than Expedia.