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Morningstar | Expedia's Investments Continue to Support Its Network Advantage; Shares Undervalued

Expedia shares are trading at an attractive margin of safety to our $185 valuation, which we don't expect to materially change, after the company's third-quarter offered support to our stance that its incremental international (45% of total sales in the quarter) and HomeAway (13%) investments are pursued for offensive reasons (large, growing market opportunity) rather than defensive ones (increasing competition).

Constant currency international bookings rose 31% on a two-year stacked basis (12% year over year), near the 33% reported last quarter, which we find encouraging given marketing spend pullback on various metasearch channels that skew heavily to overseas users, leading to less traffic. For instance, Trivago saw a 26% drop in marketing expense in the quarter. Also reassuring is that organic property growth was up 46%, remaining on track for 40% growth in 2018, as Expedia delivers on its commitment to build out its overseas content offering, supporting its network advantage (source of its narrow moat). Further, due to success seen in its international investments in 2018, Expedia plans to build out other foreign market content in 2019, something we already account for in our model, as we don't expect much change to our 14% annual overseas bookings growth over the next five years.

HomeAway two-year stacked revenue growth accelerated for the third straight quarter to 80% (up 34% year-over-year) versus 63% last quarter, despite the aforementioned pullback in marketing spend, supporting our 25% annual sales growth forecast over the next five years for the segment. Additionally, HomeAway's trailing-12-month EBITDA margins are up 200 basis points to 26.2% versus the year prior, aiding Expedia's increased 2018 EBITDA growth guidance to 10%-12% from 7%-12% prior, tracking in line with our 11% forecast.

Expedia deleveraged its marketing and selling expense line 344 basis points in the quarter, driven by the use of data analytics (somewhat sustainable) and a pullback in metasearch channels (we believe this benefit will end in 2019). While we expect marketing costs to slightly lever in 2018, we expect deleverage in 2019 and 2020, as Expedia continues to invest into international, HomeAway, and the Experiences markets to further support its long-term network advantage. We then expect the company to leverage its network effect in 2021 and beyond.

Finally, U.S. two-year stacked bookings growth of 17% was near the 20% level of the past few quarter, and we don't expect a material change to our 7% annual revenue growth estimate over the next five years.