Description

Summary:

I think that to say that there is “fatigue” among Expedia investors would be a significant understatement.  Over almost the past decade, the stock is flat despite revenue up ~2x, margin expansion, leverage reduction, and a decline in the share count.  On a trailing EV/EBITDA basis (debt should really be looked at on a gross basis given the deferred merchant bookings, but I’m using this metric for consistency across time periods, not for absolute valuation purposes) the stock trades at just over 6x – around the COVID and GFC lows.  Despite this distressed level, the company is growing, has only 2.3x gross leverage, has repurchased >15% of their shares over the past 15 months with ~$4.1b remaining on the authorization (>25% of the float, and CFO Julie Whalen has a history of well-executed share repurchases at Williams Sonoma), and a new CEO who is highly regarded.  Last year’s FCF was negatively impacted by a normalization in the post-COVID deferred merchant bookings surge, and despite that the stock trades at a >12% yield on that cash generation.  I think the reason for the extreme investor fatigue around Expedia, as evidenced by what I think is a very large fundamental vs valuation mismatch, is that over the last decade investors have had to bounce from Dara leaving for Uber, to Mark Okerstrom’s poor management and subsequent firing, to COVID, to a technology stack re-platforming that muted the COVID rebound, to another management change, to laying off 9% of the company’s workforce, and some poor forecasting.  Quite the run.

I think that the current negative narrative is (to simplify) that the much-lauded tech re-platforming is not generating the expected benefits, and as a result Vrbo is being exposed as a troubled asset, layoffs have been executed to staunch the bleeding, and Peter Kern decided to pull the ripcord.  I don’t believe this to be the case.  I think that while the forecasting of the transition through the tech re-platforming has been poor (this is a case of real life vs a spreadsheet) Vrbo remains a high quality asset that is following a constructive trajectory, I believe the layoffs are a benefit of the tech re-platforming, and I believe that the management change has been planned and that the new CEO looks promising.  Due to negative circumstances, the market is treating Expedia as troubled legacy tech, despite the cheap valuation and bright prospects.  I think that Gartner during the 2017-2020 integration of the Corporate Executive Board, and GoDaddy during their product reinvestment repositioning and tech re-platforming over the past few years, are interesting analogs re: this dynamic.  Both companies reached very compelling valuations, were under-levered with large share repurchase programs and strong FCF, and have seen very strong performance as a result of their hard work and willingness to undertake short-term pain for long-term gain.

The Business:

For simplicity, I am going focus on the core B2C OTA business, and Vrbo (both reported as B2C, but somewhat different businesses).  The company also has a sizeable B2B business that has consistently been doing well, and a smaller advertising business.

I believe that the core OTA business is a good one, and has gotten stronger over the years.  The business has survived and thrived through many transitions / issues that have concerned investors.  One significant transition was from SEO to SEM as Google increased the number of paid ads above the fold.  In order to strengthen their SEO presence, Expedia purchased a lot of different brands so that they could promote SEO relevancy through cross-linking their different pages / properties.  As Google began to increase the number of paid listings above the fold, SEO became less important, and Expedia had to develop better SEM capabilities.  Today they not only have maintained excellent economics, despite the shift towards SEM vs SEO, but the company is renowned for being a very sophisticated search engine marketer.  Furthermore, the recently completed tech re-platforming has allowed the company to consolidate marketing teams, and shrink their brands from >20 down to a core three further improving the efficiency of their marketing; prior to this re-platforming, brands would actually compete against each other.  Another concern that I believe has been assuaged over time are the Google and metasearch “threats”.  Due to the fact that Google makes so much money as a travel advertiser, and that hotel bookings, where supply is a competitive advantage, are the bulk of OTA profits, these perceived threats have not manifested themselves in deteriorating economics for OTAs.  Where that leaves us today is Expedia operating in what is essentially a very profitable duopoly.  Lastly, fundamentals are proving this out; last year Expedia’s hotel gross bookings grew 18%, and in Q1 they grew 12% (above Booking.com’s 10%, fwiw).  Additionally, supply on the platform continues to grow nicely YoY.  In summary, I believe that Expedia is a critical piece of the hotel supply distribution value chain, has significant scale economies, and growth opportunity.

Despite the decline in Vrbo performance last year and the lackluster start to 2024 (more on this later), I believe that Vrbo remains a very good business with strong prospects.  Vrbo has strong brand awareness in the rural, whole-home segment of the vacation rental market, and matches that demand with a strong base of supply, to create what I think are durable network effects in a large and growing market.  While Vrbo’s demand trends have recently been impacted by short-term issues (again, more on that later), the supply side of the network remains very strong.  While Airbnb touts their supply growth and unique listings on their earnings calls and in their shareholder letters, Vrbo has similar and strong metrics – one just needs to talk to the company and read the K’s/Q’s to get them.  For reference, the percentage of listings that are unique to Vrbo are >50%, and Vrbo’s supply grew ~20% in Q1.

A few supporting quotes from former Expedia employees:

“there will always be space for OTAs and for lots of different OTAs, and for airlines selling hotel rooms and because every supplier knows that their inventory waste goes to waste every night if they don't have a head in that bed. And so everyone in the industry knows like broad distribution is critical. You want as broad a distribution as possible.”

“Expedia has massive economies of scale in the industry”

“Even in North America, where Expedia is the market leader, I think it might just break double-digits percent of market share. There's still incredible opportunity in North America. The challenge in any region isn't whether there's opportunity. There's massive growth potential in every country. What Expedia has to do is decide where it's going to place its next dollar, if that makes sense. For me, Expedia's strengths are obviously the North American inventory supply is really, really strong. Countries that have a big outbound travel to North America”

Tech Re-Platforming:

As a result of Expedia’s acquisitive history, the company had a significant number of brands that each had their own marketing team, product teams, etc.  What on the outside looked like a very large OTA, on the inside looked like multiple smaller ones / a heavily duplicated cost structure.  Over the past three years the company has been addressing this by undertaking the long and arduous process of consolidating brands and moving the remaining ones onto a single, integrated tech stack.  This should have two very positive impacts on the business.  First, a single tech stack should massively increase the company’s ability to test and release across the organization (we’ve already seen indications of this at Hotels.com which has completed its re-platforming).  Second, it should allow the company to consolidate functions and teams, resulting in a much more efficient cost structure.  We’ve already seen indications of the latter with the announcement earlier this year that the company was laying off ~9% of their workforce.  However, given the timing of this announcement coinciding with a guidance reduction and management change, I believe it was taken more of a negative signal than a positive.  Not to mention the fact that this massive increase in efficiency is being reinvested in the near term to re-filling the brand marketing hole that the company created for itself last year (more on that in a bit).

A few supporting quotes from former Expedia employees:

“So when I got to Expedia that was 2016 and they still had like a house of brands type approach. Orbitz and Travelocity were both on the expedia.com platform, but Hotels.com was on its own platform. You have Hotwire on its own platform. And they had all the different brand teams that we're pursuing those various goals and whatnot.

And it didn't take a rocket scientist to see that it probably would, at some point, running all these independent groups, you're going to want to drive some optimization and some efficiencies, at least on marketing spend, if nothing else.

The move to do that made a ton of sense. And obviously, with technology, the way that you gain economic leverage in that space is by driving scale. Having different tech stacks without really that much difference in the utility of the tech stacks didn't make a whole lot of sense. I mean it's not like Booking.com. They have lots of different enterprises, but you wouldn't try and put open table on the Priceline stack. That wouldn't make any sense because it's a completely different business.

But when you've got H.com and expedia.com, and they're basically doing the same thing at the end of the day. Even Airbnb to some degree is pretty similar to what they're trying to accomplish. That all made a ton of sense and when they decided to go down that road, that was no surprise.

And I think what Peter Kern has come in and done is he's like added a lot more urgency and velocity. And you probably have it in front of you or no, quicker than I would, but I think you started it right before COVID launched so maybe December of 2019, I think, is when he took over as CEO, it's taken a while to get to this point, for what they had to accomplish, I think they've gone pretty quick.

It's like it's the old adage of changing the engines on the airplane while you're in flight. It's tricky to do all that and retain all the subject matter knowledge and keep the process going as you need to. I think that consolidation has been successful, and I think it's going to set them up to be really competitive.”

“Expedia grew quite a lot through acquisition. We bought Orbitz Group. I think at one time Expedia had 17 different brands.  What that meant was if you take one element of the website, and the simplest one to sometimes understand is the checkout path, you've decided what you want to buy, and you're just saying, "I want to give you my credit card details now," Expedia had 17 different teams go and build a checkout path just through the nature of the business. Because we bought companies and with that comes all of the teams and we had let them run and compete with each other for so long, we ended up with this massive duplication of resources.  Obviously, with some of those smaller brands, you put them straight onto the brand Expedia platform. Essentially, what's happened recently is they've completed more of that migration work. It's not so much that Expedia hired up for migrations. Expedia was duplicating costs because of the complexity in its ecosystem, and it's now been able to step it down.”

““It's almost Expedia completing its platform journey. Here's what I was trying to say. Expedia's announced to cut resources isn't a reaction to something external. It's not like, "Hey, we're worried about airline prices, so we're going to cut our tech team because we've got to tighten our belt." This is just where Expedia is in the journey.”

“Do I think that there's more to come in terms of technology efficiencies? Yes, I think there is more opportunity definitely. I'm talking in the tens of millions, up to $100 million a year of opportunity to become more efficient in the technology space. Am I confident that Expedia will deliver that based on its track record”

“COVID was exactly what they needed, a couple of years where their results didn't matter and they could do this very aggressive and very disruptive transformation, and just like not be concerned about how it affected their results because nobody had any expectations anyway.”

Management Change:

While Peter Kern’s announcement that he was stepping down as CEO right as the company was emerging from its tech re-platforming was taken as a bit of a surprise, and as a negative signal, by the market, I believe that it was a long time coming and that the new CEO, Ariane Gorin, looks very promising.  First, I think it’s worth noting that Peter will remain as Vice Chairman of the company, the position he held prior to taking over as CEO when Mark Okerstrom was fired.  Second, my understanding is that Mark was fired because he was trying to navigate some of the changes that the tech re-platforming addresses, but without impacting the financial results – a fast track to mediocre performance.  When Peter took over for Mark, it was quite explicitly on an interim basis, and he has been quite transparent that he has stayed in the CEO position for longer than he expected, but that he wanted to see the tech re-platforming through to its conclusion.  This goes back a bit further, but I think that on top of the perception of Peter’s retirement is the fact that Back in 2017 Dara, who was highly regarded both internally and externally, left Expedia for Uber – for what it’s worth, I think that Dara was quite happy at Expedia, and the Uber opportunity was a unique one and took some convincing (decent take on that in this interview, fwiw - https://www.acquired.fm/episodes/uber-ceo-dara-khosrowshahi).  Compounding the apparent surprise at Peter’s retirement / return to just the Vice Chairman role seems to be surprise at and little knowledge of Ariane Gorin as the next CEO (took the helm just a few short weeks ago).  Confounding this perception is a remarkably consistent narrative from former Expedia employees that Ariane; 1) was the most likely choice to succeed Peter, 2) is well positioned / equipped to succeed, 3) has an impressive track record within the organization, and 4) is very well liked within the organization.  When talking to a friend who previously worked for Expedia for the better part of a decade, he/she remarked that they loved working for Ariane and that while they very much liked Peter, Ariane’s appointment as CEO made them wish they were still at the company.  In summary, the Expedia CEO role has been a bit of a revolving door over the last decade, periodically and consistently leaving a bad taste in investors mouths.  I believe there is a strong chance that Ariane marks a significant change to that fact pattern, and that she is well-equipped to lead a structurally-changed (for the better) Expedia for the foreseeable future.

A few supporting quotes from former Expedia employees:

“She is incredibly brilliant”

“She's just a phenomenal person. She is someone that I view as a leader and somebody that I want to continue to be like because she's that phenomenal.”

“when the announcement came out and announced Ariane as being CEO, and one of the articles I read, it was like, "This was a surprise." And I thought myself, "Not a single person at Expedia thought this was a surprise." Like the writing had been on the wall for years. So I thought it was really interesting.”

“I think she is well equipped to succeed as the CEO. As an employee at a competitor, I am like, "Oh, wow." Because everything she has touched thus far, and this is cliche, has turned to gold. So I believe that she will do a great job.”

“I don't think it would have even been close between her and anyone else”

Guidance / Vrbo near-term fundamentals:

Vrbo-driven gross bookings guidance is the latest culprit for poor Expedia stock performance.  Vrbo is the last piece of the business to go through the tech re-platforming and management’s reduction in top line guidance on the 1Q24 call was a result of a slower-than-expected recovery at Vrbo post re-platforming.  While this is no doubt disappointing, I think it is a result of poor forecasting rather than structural problems.  First of all, as noted before, supply metrics at Vrbo continue to be very strong.  Second, while the recovery path at Vrbo has been slower than expected, it is recovering.  In a business like Vrbo, conversion drives marketing spend, and marketing spend drives traffic, which is then monetized, reinvested into marketing, etc. – it is a circular / reflexive model.  Last year, as the company re-platformed Vrbo, they saw an expected decline in conversion, which was followed by lower marketing spend as a result, and thus lower traffic which has been compounded at the bookings level by that lower conversion.  Due to the fact that in the second half of last year, while Expedia was pulling back on Vrbo marketing, Booking.com and Airbnb were ramping marketing, as well as the fact that brand marketing has a longer lead time than performance marketing (the majority of Vrbo marketing spend is brand, vs the majority of Expedia being performance), the recovery in traffic and gross bookings has disappointed expectations.  However, importantly, the company has stated that conversion is back to above pre-re-platforming levels (and should increase further with the increased amount of test and release that they have planned for this year), that marketing spend is ramping as a result, and that traffic is improving as a result of the increased marketing spend.  Compounding the negative stock reaction, but brightening the prospects for a Vrbo recovery, Expedia lowered 2024 margin guidance to flat YoY as they expect to re-invest significant operating leverage and structural re-platforming savings into increased brand marketing at Vrbo.  In summary, supply at Vrbo continues to grow double digits, the re-platforming has driven conversion above prior levels, marketing is ramping, and traffic is following marketing.  With a double digit FCF yield and low leverage, I think that investors are being more than compensated for some poor forecasting of the Vrbo inflection / recovery.

Conclusion:

Expedia’s stock has been flat for nearly a decade and is trading near all-time valuation lows as a steady flow of issues / negative events has grown the “Recovering ex-Expedia Investor” population to that of a decent-sized developed economy.  However, the company is now in / around an inflection where the company is structurally improved from both a management and operational perspective, and the stock is primed with a >12% FCF yield, only 2.3x gross leverage, and a massive and ramping share repurchase program.  On earnings only 12-24mos out and a mid-teens earnings multiple / M-HSD FCF yield, I think Expedia shares can roughly double.

Catalyst

Massive share repurchases

Vrbo recovery