Description

TripAdvisor: Knee-Jerk Reaction to ~2.6% Decrease in Hotel Shoppers in 2Q 2018 Caused by Massive Reduction in Performance Channel Marketing Creates an Opportunity to Buy Fast Growing Experiences and Restaurants Businesses + Hotel Business that Is Finally Turning Around

Over the past two years TripAdvisor was written on VIC twice.  Macrae538 wrote mostly about how transition to Instant Booking as a new business model would be a success which did not happen.  Value1929 painted a picture with very broad strokes (i.e., 40 thousand fee view) that Non-Hotel Business is valuable.  My goal is to explain why Non-Hotel Business would be valuable by diving into unit economics and quantifying the growth runway which has not been done on VIC before.

In mid-2014 TripAdvisor did two very successful acquisitions: Viator and La Fourchette.  Viator is a marketplace for attractions, tours, and activities. La Fourchette is an online restaurant reservation system in Europe similar to OpenTable in the U.S.

Both Viator and La Fourchette were great platform businesses (i.e., businesses that bring demand and supply together and benefit from a network effect) at that time of the acquisition.  However, TripAdvisor was able to put them on steroids and accelerate their growth. Here is why. A typical platform business needs to bring supply and demand together which is not an easy task.  While both Viator and La Fourchette successfully overcame the chicken-and-egg problem, acquiring additional demand (i.e., consumers) and supply (attractions providers / vendors and restaurants) would be a step-by-step process.  TripAdvisor has a unique position in the ecosystem because it has millions and millions of people visiting its website and using its app.  In other words, TripAdvisor was able to bring massive demand to both Viator and La Fourchette right away as opposed to them growing traffic incrementally.  TripAdvisor kept both websites operating under their own web identities AND integrated their back-end into TripAdvisor.com.

In addition, TripAdvisor has been using cash flow from its Hotel Business to invest in Attractions (now renamed as Experiences) and Restaurants.  Most of those growth-related expenses went to building up supply. As a result, both businesses have been losing money because of the heavy sales and marketing expenses necessary to build the networks for almost their entire existence and have thus received very little attention from sellside analysts, who often do not even model them separately.  TripAdvisor itself has not helped by disclosing as little as possible about these businesses.

Restaurants and Attractions experience 30%+ growth and face a long growth runway because the number of bookable restaurants / attractions can increase 30% to 150%.  In addition, the usage (i.e., user engagement) should be growing as well.  Please see more on this in business-specific sections.

This massive growth coupled with radical, breakthrough margin expansion may sound hard to believe.  However, a careful study of the platform business model shows that this is exactly what happens to successful platform businesses.  OpenTable is a case in point.  OpenTable’s EBITDA margins went from negative ~46% EBITDA margins to positive ~40% EBITDA in a few years while OpenTable grew its revenue 16x over the same period (2004 – 2013; North American business only).

TripAdvisor’s Non-Hotel Business has already shown the same tangible and clearly identifiable signs of inflection starting 2Q 2017 that OpenTable showed immediately before its meteoric rise.  Non-Hotel Business incremental EBITDA margins have been consistently above 60% in each quarter of 2017 before dropping in 1Q 2018 and 2Q 2018 due to accelerated growth in the number of attractions.

Most market participants do not appreciate the quality of businesses that TripAdvisor has built and seem to apply linear thinking to non-linear businesses.  The key insight that Mr. Market is missing is the fact that user engagement (for example, reservations per average restaurant for an online reservation business) grows non-linearly with every new restaurant added to the platform.

Restaurants Business Valuation

The Restaurants Business makes money in Europe the same way as OpenTable does in the U.S.: by facilitating restaurant reservations on its platform.  In addition, TripAdvisor is working on more products that would generally antically revenue such as premium listings for restaurants.

The unit economics and revenue model of the Restaurants segment are beautifully simple.  Restaurants Business revenue = number of restaurants on the platform * seated diners per restaurant * fee per diner.  In 2017 the Restaurants Business generated ~$90M of revenue = 44,500 restaurants (average during 2017) * 1,124 seated diners per restaurant * $1.80 fee per diner.  

From 2015 to 2017 TripAdvisor doubled the number of diners it brought to restaurants from 25M to 50M.  TripAdvisor achieved such massive growth because it has brought supply and demand together.  It brought supply – restaurants – by acquiring La Fourchette and then signing up even more restaurants.  It also brought demand – diners who have been consuming and generating content on its website but who lacked the ability to book those restaurants on tripadvisor.com.

Driver #1:  Number of Restaurants.  TripAdvisor acquired La Fourchette in mid-2014 when it had ~14,000 restaurants on its platform.  TripAdvisor has grown the number of restaurants on its platform to ~51,700 at the end of 2Q 2018 or ~3.7x growth / ~40% CAGR.

Despite this tremendous growth the penetration remains very low: only ~1.1% of restaurants reviewed on TripAdvisor.com are currently bookable through the platform.  Having 51,700 restaurants bookable on its platform makes TripAdvisor the biggest player in Europe as a whole and in almost all countries where it operates on a standalone basis.  I expect the number of restaurants on the platform will increase to at least ~65,000 by 2022.

Driver #2: Seated diners per restaurant grew from 787 (2015) to 1,124 (2017), a 19.5% CAGR.  This metric is disclosed only on the annual basis, and I cannot reliability triangulate it for 2Q 2018.

OpenTable’s business in North America is the best proxy for what is likely to happen to seated diners per restaurant for TripAdvisor.  OpenTable grew its seated diners per restaurant from ~2,600 in 2005 to 6,600 in 2013 for a ~12% CAGR as more restaurants joined the platform.

To put things in perspective, TripAdvisor has fewer seated diners per restaurant in Europe in 2017 than OpenTable had in 2005 in the U.S. despite the massive increase in smartphone penetration.  This results in a massive growth runway for the TripAdvisor Restaurant Business for many years.

Seated diners per restaurant is the most important driver for the Restaurants Business.  I use 2,600 seated diners per restaurant in 2022 in the bear case (OpenTable in North America level in 2005), 4,000 seated diners in 2022 in the base case (OpenTable in 2008), and 6,600 seated diners in 2022 for the bull case (OpenTable in 2013).

Driver #3: I expect that fee per diner will remain flat ($1.80).

EBITDA Margin: Other platform businesses have 30% to 40% EBITDA margins.  OpenTable in North America had ~38% to 43% EBITDA margins in 2011 to 2013 (after stock-based compensation).  I use 20%, 30% and 40% in my bear, base, and bull cases.

Multiples: Network effect is the strongest moat that I know of and businesses that exhibit such moats trade at very high EBITDA multiples.  Thus, my multiple range of a 12x to 16x EBITDA multiple for TripAdvisor Restaurants is reasonable. Below I provide a valuation summary:

Attractions Business Valuation

The Attractions Business makes money by facilitating tour, sightseeing spots, museums, and other travel activities bookings on TripAdvisor platform (website or smartphone app).

The best way to think about the Attractions Business is to think about it as an OTA for travel attractions and experiences.  TripAdvisor typically charges vendors commissions between 20% to 25% which compares favorably to 15% to 20% that OTAs charge hotels.

The Attractions Business had revenue of ~$180M in 2017 and has a long runway for growth.

TripAdvisor acquired Viator in mid-2014 when it had ~20,500 attractions on its platform.  TripAdvisor has grown the number of bookable attractions to 121,000 at the end of 2Q 2018 or ~5.9x growth / 50%+ CAGR.  Despite this tremendous growth, penetration remains very low: only ~12.5% of attractions that are reviewed on TripAdvisor.com are currently bookable through the platform.  TripAdvisor is the biggest player in the space (2x the size of the closest competitor, Expedia, based on my estimates) and competitors are far behind.  I predict TripAdvisor will increase the number of attractions on the platform to at least ~150,000 by 2022. I expect the number of bookings per attraction to grow at 15% to 30% a year for the next few years due to increasing user engagement.  These two drivers together will bring revenue growth to 20% to 30% a year.

I estimate that 2017 Attractions Adjusted EBITDA (before stock-based compensation) was ~$29M, a ~ 16% Adjusted EBITDA margin.  However, the Attractions Business demonstrated its massive operating leverage in a seasonally strong 3Q 2017 when its EBITDA margin was 50%+.  As the platform scales, margins will expand.  I view a 30% to 45% range as reasonable.

Thus, the combined value of the Restaurants and Attractions varies between ~$15, ~$34.5 and $75 in bear, base, and bull scenarios.  Importantly, both businesses will grow and compound their value beyond 2022.

Other Goodies

We have not even touched upon Vacation Rentals ($1 to $2 value per share), net cash (~$4.9 per share), cash build up between now and 2022 (~$1.50, ~$4, and $7), and per share in my bear, base, and bull cases).  Plus, TripAdvisor still has what everybody talks about – the Hotel Business!

Hotel Business

Despite the popular view, I believe that, as Mark Twain is often misquoted, the reports of the TripAdvisor Hotel Business’ death “are greatly exaggerated”.  Here is the best evidence: (1) the number of monthly unique visitors continues to grow (up ~9.9% in 2Q 2018), (2) user engagement measured by the number of reviews written remains incredibly healthy (e.g., reviews grew ~23.5% in 2Q 2018).

The monetization issues are mostly caused by failed Instant Booking rollout (self-inflicted) and a shift to mobile and not by changes in the competitive environment.  Importantly, TripAdvisor has improved its mobile monetization from ~20% of desktop monetization a couple of years ago to ~40% in ~2Q 2018.

2016 Hotel EBITDA was depressed by the failed Instant Booking rollout while 2017 was depressed by TV advertising campaign (~$74M).  To normalize the Hotel Business’ profitability I take the average EBITDA of two years. Below I provide a valuation summary.

To put things in perspective, 2Q 2018 LTM Hotel Adjusted EBITDA = $291M after $114M of TV advertising expense.  If – as a thought experiment – we ignore $114M of TV advertising expenses, Hotel Adjusted EBITDA would have been ~$405M!  Obviously, we cannot ignore TV advertising expenses in their entirety.  However, a big chunk of the TV ad spend budget would generate ROI only in 2019 and beyond as opposed to immediately payback in 2018 (which is the case for performance channel marketing dollars).

On top of this, Hotel Adjusted EBITDA grew for the first time in 2Q 2018 (up ~6%) for the first time since 4Q 2015.  This growth was achieved despite large TV advertising expenses.  Thus, I expect Hotel EBITDA to continue its growth due to (1) better performance-channel marketing (i.e., no break-even marketing anymore), (2) mobile becoming tailwind as opposed to headwind over the past several years, (3) lapsing lower-revenue per hotel shoppers (3Q 2018 would be the last one where year-over-year comparisons are challenging).

TripAdvisor Valuation: Putting It All Together

Again this valuation assumes no improvement in Hotel Business even though I feel quite confident that we would see strong improvements.

Catalyst

1.   Continuous Non-Hotel revenue growth.

2.   Margin expansion of Non-Hotel business.

3.   Growth in Hotel EBITDA starting 4Q 2018 as difficult year-over-year comparisons lapse.

4.   Increases in revenue per hotel shopper as mobile becomes more than 50% of traffic over time.