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Morningstar | Booking in a Near-Term Transition Phase, but Long-Term Competitive Positioning Appears Intact

While we continue to see Booking as the best-positioned travel network (the source of its narrow moat) for long-term growth, we see its shares in a near-term transition period as the firm tries to balance growth and profitability, leading to booking deceleration in 2018. We plan to reduce our $2,300 fair value estimate by a mid-single-digit percentage for lower 2018 bookings growth, mitigated by lower near-term marketing expense, leaving shares undervalued. We reiterate that Expedia shares are at an attractive margin of safety.

Bookings grew 15% versus our 16% estimate and guidance of 10%-14%. On a two-year stacked basis, bookings rose 31%, down from 45% last quarter, a deceleration last seen in early 2017 and 2013. Further, management expects third-quarter bookings to rise only 3%-6%, implying a two-year stack rate of 22.4% at the midpoint. While we view this guidance as conservative, we think the deceleration is due to both a prudent pullback in performance marketing (which we reiterate is temporary) and potential maturation.

Booking saw marketing leverage for the third straight quarter, moving down 517 basis points to 36.8%. While this aids profitability, it can also hinder bookings. We reiterate our view that the industry pullback in performance channels will prove temporary (given the traffic and improving conversion of networks like narrow-moat TripAdvisor), which should aid TripAdvisor's growth. We also think that Booking might be bumping up against maturing growth in its core European market, around 50% of total bookings, although it will take more than one quarter for us to assess whether this is a lasting trend.

We plan to reduce our 2018 and 2019 bookings growth estimate to around 12% and 12.5%, respectively, from 17% and 13.5%, while maintaining our out-year forecast. Meanwhile, we look to lower our marketing spending as a percentage of sales about 150 basis points in 2018 to around 35%, while keeping our out-year forecast largely intact.

Although it creates near-term volatility in results, we agree with Booking Holdings' long-term vision of leaning into brand marketing (to push direct bookings), seeking efficacy in performance channels, and continuing to invest in growth areas like Asia-Pacific (with its recent Hotels Combined meta-acquisition) and experiences (where it has begun to build out content). Booking commented that direct is around 50% of its traffic and growing, which supports our view that the company's network advantage is strengthening.