EUR 850.00 For Business Accounts Only

Morningstar | Narrow-Moat Expedia's Investments Supporting its Intact Network Advantage; Shares Undervalued

We don't plan a material change to our $180 fair value estimate and believe narrow-moat Expedia's second quarter offered further support to our stance that its incremental international and HomeAway investments are pursued for offensive reasons (large, growing market opportunity) rather than defensive ones (increasing competition). We still expect reaccelerating EBITDA growth into 2019 as Expedia realizes return from these investments (as was the case with incremental investments made in 2015). Shares are trading at an attractive margin of safety despite the roughly 30% appreciation since Expedia's first-quarter earnings report.

Global bookings were solid with U.S. (63% of total) lifting 10% versus our 5% estimate. Importantly, after showing notable deceleration in third-quarter 2017, domestic two-year stacked bookings growth has stabilized the past three quarters at around 20%, alleviating maturation and competitive fears. We plan to lift our U.S. 2018 bookings growth estimate to 10% from 9%, while maintaining a stable 10% take-rate. Meanwhile, foreign bookings (37%) posted 19% growth, ahead of our 17% estimate, with the geography's constant currency two-year stack lift remaining in a stable 30%-plus range with the last few quarters. Also, international take rates (excluding Trivago sales) remain stable, supporting that current investment into priority markets is not coming by way of promotion. Encouragingly, Expedia commented that investments into priority foreign markets are showing early signs of room night acceleration, buoying our view that the company will see a positive return from this initiative.

HomeAway (11% of total bookings) investments are also yielding healthy results, witnessed by 33% sales growth (two-year stacked lifted 63% and accelerated for the second straight quarter) with EBITDA margins of 26.3%, up from 17.4% in the prior year.

Bookings results were solid, despite Expedia leveraging marketing expense by 229 basis points to 53.5%, the first yearly improvement in a quarter since third-quarter 2016. This efficacy is impressive during a time when the company is ramping investment into HomeAway and international markets. As a result, Expedia increased its 2018 EBITDA growth guidance range to 7%-12% (10%-16% excluding cloud investments) from 6%-11% prior (10%-15%), compared with our existing 8% estimate. Although we plan to lift our 2018 EBITDA growth forecast slightly to around 9%, we expect Expedia will accelerate its HomeAway investments over the next several quarters, while also looking to gain further network advantages in additional foreign markets in 2019 and future years. As a result, we continue to expect marketing deleverage until 2020, at which time we believe Expedia will begin to benefit from its network advantage, ultimately driving EBITDA growth back to midteens in 2020 from a high-single digit rate in 2018.

Finally, we are encouraged that Expedia has repurchased $450 million year-to-date (at an average price of $112 per share), which already eclipses any full-year amount since 2014. We view this as a good use of capital and a vote of confidence from management that it expects its investments to pay dividends.