Description

This is a quick write up on a simple thesis.

Priceline (PCLN) stock has fallen 24% YTD. The stock trades 14x earnings. As you probably know, this is an extremely profitable company with a long secular growth runway. Online penetration of the hotel industry globally is still ~50%. I wouldn’t be surprised if in 20 years, that figure is 95%.

PCLN and Expedia (EXPE) have basically killed or acquired all of their rivals (outside of China) in recent years. They’ve stood up to assaults from Google.

PCLN also generates huge FCFs (~$3bn run rate). Unlike in prior years, the company is buying back very significant amounts of stock. Historically, PCLN has done better than EXPE because of its hotel heavy mix, and because of its non-US focus, where chain hotels are rarer.

Incremental capex needs are low. So if the firm grows, FCF will increase disproportionately.

Although growth will likely slow, it will likely still hit mid-teens to high-teens for the next several years, absent a very bad recession.

The math is extremely compelling. So what’s the bear thesis?

1.      Macro – travel demand, hotel revpar, FX, etc

2.      Airbnb

First, let’s talk about macro. Priceline is Euro heavy, which was a big drag last year. This year, the EUR has actually strengthened vs the USD slightly. In the longer term, I think the FX issue washes out. As for cyclical risk, I’m personally willing to look thru the cycle. Even if we take a draconian assumption that the hotel industry revenues fall 10% in a recession, I’d bet PCLN’s secular growth would keep revenues relatively steady. It wouldn’t take much penetration / share gains for that to happen.

Airbnb

There are two risks with Airbnb:

1)      Airbnb will disrupt the hotel industry entirely

2)      Airbnb will morph into an OTA and compete with PCLN/EXPE directly. They will take on hotel inventory.

I personally think the first threat is more dangerous.

Airbnb has 80 million room nights. Round numbers, EXPE has 200 million and PCLN has 400 million. I estimate the “overnight accommodations” TAM in US + Europe to be ~2.5-3bn room nights.

So, Airbnb is a relatively small presence today, but because of its fast growth, it can become a much more significant factor in the next 3-5 years.

I don’t want to dismiss the disruptive threat (and am looking forward to the discussion thread here), here is my argument that Airbnb won’t “massively” disrupt the hotel industry. I assert that a “mild” disruption, characterized by modest revpar pressure and modest share losses by hotels won’t kill the PCLN thesis (because of the penetration runway + low valuation + share buybacks).

·       Numerous regulatory issues that will need to be addressed.

·       The need to collect taxes and meet regulatory hurdles (e.g. safety/fire related, record keeping, insurance, limits on rentals, etc) will erode the value advantage of Airbnb over time

·       Airbnb is fundamentally a different product than hotels: many more frictional issues, uncertainty of bookings, having to deal with the host, not knowing what to expect with each property, no service or amenities, etc... that the addressable market isn't massive, and this addressable market is halfway INCREMENTAL to traditional travel as opposed to cannibalization

·       Hotels will evolve to meet the airbnb threat. At minimum, rev par will fall enough that Airbnb will cease to be such a good deal, and the market will stabilize. In general, hotels will find ways to lower their cost structures or to differentiate from Airbnb. Hotels will also hang onto the corporate market.

On the flip side, here are the “pro-massive disruption” arguments that make sense to me:

·       Barriers to entry to being a "mini hotellier" has been massively lowered by Airbnb

·       There is a huge amount of real assets that is being under-utilized out there (e.g. empty 2nd homes, spare bedrooms, investment properties, etc) that could be put into service for low incremental cost. Even if utilization per property is low, the sheer volume of properties out there could swamp the hotel business.

·       Airbnb will continue to enhance its service -- enable more instant booking, break into the corporate travel market, improve dispute resolution, etc

·       Hotels will find it difficult to counter Airbnb, given high fixed costs, higher regulatory burden, innovator's dilemma, etc.

Now, I see the merit of both sides, but I think at the current valuation, the disruption threat is farther away and less serious than implied by the market. Frankly, if ANY of the “anti-disruption” issues resolves against Airbnb (or if execution falters) it won’t be massively disruptive.

The next issue is competition to OTAs. The argument is that Airbnb will take on hotel inventory and become a powerful third OTA.

While I think this is a more likely scenario, I think the impact is far less serious to PCLN.

·       Airbnb’s take rate is not super low… In my experience, they’ll take ~10-12% from the user + 3% from the landlord + 3% currency conversion fee if applicable. The take rate is actually very similar to OTAs. I don’t think their cost structure will let them disrupt OTAs on sheer pricing.

·       The Airbnb customer is so different from an OTA customer, that Airbnb's "organic" traffic will not convert well into HOTEL bookings. To compete with OTAs, Airbnb will have to buy traffic just like everybody else for this customer segment.

·       History has shown us that it's not easy to get hotel inventory... particularly for the smaller/independent properties. This is a chicken and egg problem -- when you don't have the bookings, hotels don't want to deal with you... but you can't get bookings until you get the properties. Without the properties, you can't pay enough for traffic and hope they convert well. (Other issues, like lack of reviews and detailed pictures, etc also play here)

·       All the stuff that really differentiates Airbnb  -- reducing information asymmetry between landlord and renter, dispute resolution, etc are pretty much irrelevant in the hotel OTA realm. In fact they may be at a disadvantage to incumbent OTAs who have much more experience in the business.

·       The OTAs I think have earned some benefit of the doubt when going up against “horizontal” competitors. After all, both PCLN and EXPE have thrived in a competitive market place and ended up getting rid of all significant direct rivals.

Also, I will point out that you can at least partially hedge the disruption risk by shorting a basket of hotel chain stocks. There is a thesis out there that hotel chains will be resilient to Airbnb threat because they skew business travel. This is true. But how can Revpars stay high, if their competitors are getting disrupted by Airbnb? If Airbnb disrupts hotels as a business in a serious way, the ripple effects will affect all hotels. I don’t think the chains will escape.

Another hedge would be the WYN / VAC’s of the world. I think these are at much more serious risks to disruption than even hotels.

Conclusion:

In my mind, 90% of this thesis hangs on one point – what is the future of Airbnb?

I think with the massively negative sentiment and low valuations, PCLN (and frankly EXPE) is a pretty good risk /reward

Catalyst

Wait and see...