Description

Following the spinoff of TripAdvisor from Expedia expected December 21^st (tomorrow), we recommend a long position in TRIP. Shares of TRIP are expected to trade at c. $28.50 and we see fair value at $33-35, i.e.  approximately 20% above current value.

Background and Business Description

TripAdvisor was founded in 2000 by Stephen Kaufer and he remains the company’s CEO today. TRIP was acquired in 2004 by IAC in 2004 and later span off in 2005 along with Expedia. From 2005 till December 2011 TripAdvisor traded as subsidiary of Expedia. IAC is the investment vehicle controlled by Barry Diller. Barry Diller retained majority voting in Expedia following the spinoff in 2005 and will retain voting control (60%) over TripAdvisor.

TRIP is a pure play travel focus media company. TRIP boasts over 20m members worldwide who have posted over 50 million reviews on hotels and restaurants worldwide. TRIP’s members have historically shown  a degree of loyalty and a sense of “reciprocity” to the website in that visitors not only free ride reading other travellers’ reviews but they then contribute by writing their own reviews following a trip. This reciprocity ensures that the content keeps growing and is always up to date. Because of TRIP’s growing importance as must go-to website for worldwide travellers, TRIP attracts many suppliers (hotels, airlines and online travel agents) keen to advertise their services on the website. The vast majority of TRIP’s revenue (90%+) are advertising related: either click-based advertising (c. 78% of total) or display-based advertising (c. 13% of total). The remainder is subscription based revenue and other smaller revenue streams (e.g. vacation rentals).

TripAdvisor is amongst the largest players in the global online travel market with 44m monthly unique visitors. Visitors are attracted by TRIP’s content that is becoming increasingly paramount in deciding holiday destinations for millions of travellers worldwide. According to a June 2011 Nielsen research, word of mouth content is the most important source of decision making in purchasing a travel service. At the end of the day, travellers have become sophisticated customers that are naturally sceptical on suppliers’ bombastic promises via advertisements in traditional media (newspapers, TV, radio, websites). By far the most important trusted source is recommendation from other customers, preferable from customers that are known. This is exactly what TripAdvisor provides its customers:  a free access to a database of recommendations from other customers.

TripAdvisor is also a social media. It is integrated in other social media like Facebook (57m Facebook connections) and is in itself a community of travellers. Other travellers value their friends’ recommendations more than anything and this content is extremely valuable to suppliers.

TRIP’s strategy is to grow its customer base in a virtuous cycle: better content (i.e. better and more complete reviews) attracts more customers which, in turn, will add to content quality. This virtuous cycle stimulates traffic and TRIP monetises this traffic via advertising.

TripAdvisor also owns other important properties, in particular:

• SniqueAway.com – a website dedicated to TRIP’s top hotels. Average cost per click is much higher given the higher quality of hotels and therefore the higher average room fare
• DaoDao / Kuxun – TRIP’s Chinese properties that include Kuxun, Chinas’ #2 metasearch player
• TripAdvisor Vacation Rentals – TripAdvisor is the #2 global player (after AWAY) in the growing $85b vacation rental market

Key operating metrics and financials

With over 50m reviews and opinion on over 500k hotels and 700k restaurants worldwide, TripAdvisor is by far the largest travel media platform in the world. With c. 50m unique visitors, it sits at the very top of the Travel Website landscape, above Booking.com with c. 30m uniques and Expedia with 27m. It operates in 30 countries in 21 languages.

Business characteristics – why we like TRIP

Barriers to entry – TripAdvisor is in our opinion a highly defensible business with significant moats

• As mentioned above, recommendations from known or unknown people are the most crucial elements influencing a traveller’s purchasing decisions. According to PhoCusWright, 98% of participants found TripAdvisor’s hotel reviews to accurately represent the experience. It would be very hard to replicate TRIP’s vast content, both in terms of sheer size (over 50m reviews, over 8m users’ photos) and quality. Over 25 additional reviews are added every minute on the website, something that would be very difficult to replicate
• Network effects – scale generates richer contents, attracting new consumers that will enrich TRIP’s content
• No competitors have the same combination of scale (high traffic) and quality (rich content) as TripAdvisor. Google and Bing certainly have scale but poor travel specific content. Other travel media businesses like Kayak and Travelzoo have average content and no scale

 TripAdvisor benefits from long term tailwinds that will sustain high growth for the foreseeable future:

• Online growth – online travel market still underpenetrated. In the US, c. 39% of the market is already online, versus 35% in Europe, 23% in APAC and 18% in Latam, so we are still in the early innings of online penetration
• Substantial international opportunity – the international market is growing tremendously fast. PhoCusWright estimates online travel spent to grow 15% p.a. 2010-12 in APAC and 32% in Latam. TRIP’s growth in those regions will be much higher as advertising shifts online away from traditional platforms
• Substantial hotel opportunity – TRIP is mainly focused on online hotel advertising, which is a much more lucrative and faster growing market than online air. For those familiar with Priceline and its website booking.com, the international business has been growing at phenomenal rates in recent years and hotels online in the US  still only represent 24% of total versus 38% for air travel
• Monetisation of international – 75% of TRIP’s website visitor traffic comes from outside the US but only 38% of revenue is from international markets. This means that international markets being in their infancy are still under-monetised by a factor of c. 5x, i.e. on every visitor, TripAdvisor makes 5x more money in the US than internationally. To put things in perspective, assuming that monetisation in international markets increases to half of US levels, it’d imply over 50% revenue upside for TRIP overall
• Mobile – mobile travel spend expected to be over $2bn by 2014 growing at 40% a year according to IDC. TRIP’s app already had over 10m downloads
• China – large opportunity for TripAdvisor where they also have the 2^nd largest metasearch website
• Vacation rentals – booming market, TRIP is #2 players after AWAY. TRIP already has 200,000 vacation rental listings. Unlike air and to a certain extent hotels, vacation rental is a very fragmented market with very high margins given the high ticket items sold
• 2007-2011 CAGR of 33% doesn’t seem to slow down: LTM sales of $607m is up 33% from previous year, Q3 2011 is up 30% over Q3 2010

 Healthy margins and cash generation

• Unlike many recent IPOs of over hyped social media companies, TRIP has a sound history of growth coupled with expanding margins and cash generation. EBITDA margin increased from 49% in 2008 to 54% in 2010 with revenue CAGR 2007-2011 of 33% and consistent cash generation
• There will be some dis-synergies from the spinoff, mainly due to higher G&A. Post spinoff, we expect EBITDA margins to be at c. 50% going forward with potential for margin expansion, in particular due to operating leverage in G&A and technology and content costs. We assume that going forward the company will keep on spending in advertising with no operating leverage in selling and marketing which we think will stay at 33% of sales

 Efficient capital allocation and sound balance sheet

• Whilst difficult to judge TRIP’s future capital allocation policy, we take comfort from Barry Diller’s active role in overseeing the capital allocation at Expedia (focused on return on cash to shareholders via buybacks) which we think will continue at TripAdvisor. We would therefore expect substantial return of capital to shareholders and particularly efficient capital allocation strategy for an internet stock (this is not going to be a Microsoft overpaying for new businesses nor a Google hoarding cash)
• Post spin-off, we expect as of December 2011 cash balance of over $200m and Net Debt of just $160m (0.5x Net Debt to EBITDA). As part of the spin-off, TripAdvisor will inherit a $380m bond expiring in 2016

Relatively cheap valuation for high growth stock

Given TRIP’s high growth and desirable business characteristics, we would expect it to trade at premium to other media / fast growing internet stocks. Moreover, TripAdvisor is the only publicly traded pure-play travel advertising company. Travel advertising is a massive market with approximately $39bn spent in 2011 globally. Of this $39bn, less than 15% is online (c. $5bn) and IDC estimated that online ad advertising will grow at 15% CAGR until 2015. Being the only pure play on this theme, we believe TripAdvisor should fetch a premium valuation to peers.

It’s difficult to find a proper comparable universe for TripAdvisor but we belief the following  companies are a good benchmark:

• Priceline and Makemytrip – they are the fastest growing publicly traded online travel agents. Priceline trades on c. 14x EV / EBITDA and Makemytrip at c. 60x EV / EBITDA. In terms of growth characteristics, TRIP’s c. 30% organic growth is very much comparable to Priceline’s. Consensus sales growth in 2012 is for 25%, very much in line with our forecast for TRIP
• HomeAway – it’s the market leader in online vacation rental accommodations. TRIP’s vacation rental business is approximately 1/3 the size of AWAY’s. AWAY trades on 40c EV / EBITDA and c. 38x forward P/E
• Demand Media – DMD provides social media solutions for consumers. Unlike TRIP, DMD needs to pay for its content by employing writers, editors and filmmakers, so it’s a much lower quality business as they don’t fully control their most important asset, namely content. DMD trades on 20x forward P/E
• Linkedin – it’s comparable to TRIP being a social media. LNKD trades on current 90x EV / EBITDA and triple digit P/E multiple
• Travelzoo – Travelzoo is an online marketing company for the travel industry. It has over 20m subscribers worldwide that receive special offers from Travelzoo on a daily / weekly basis by email. Travelzoo makes money via advertising. TZOO trades at c. 20x current P/E
• YELP – user reviews website, pending listing
• Kayak – metasearch engine, pending listing

Based on these comps, we think that TripAdvisor valuation is very reasonable at 17x forward P/E and less than 10x forward EV / EBITDA. At our target price of $34, TRIP would still trade at 12x EV/EBITDA 2012 and less than 10x 2013, which we think is reasonable given TRIP’s growth profile and business characteristics.

Likely takeover candidate

Whilst very difficult to predict, we think TripAdvisor would be the perfect takeover candidate for someone like Google. It is exactly the kind of business that would fit Google perfectly. It makes money the same way Google does (CPC and display advertising), it’s free (key Google’s proposition) and it’s content rich. Moreover, Google already tried to copy TripAdvisor via Google Places but the results so far were not very encouraging. It’s clearly an area that Google is prioritising. In 2011 Google closed the acquisition of ITA,  a software that powers many online travel search engines and metasearch websites. TripAdvisor also provides metasearch capabilities and owns the 2^nd largest metasearch website in China. Clearly, Google could drive TripAdvisor monetisation extracting additional revenue opportunities and cost synergies (Google is the biggest source of traffic to TripAdvisor). We know Google is very acquisitive and definitely has the cash ($42bn) to acquire a company like TripAdvisor (a 40% premium offer would value TRIP at $5.5bn, equal to 13% of Google’s cash balance or just a few months of Google’s free cash flow generation). Let’s also remind ourselves that Google recently acquired Zagat, a leading restaurant reviews website. It’s clear that this is the kind of business that would fit perfectly in the Google portfolio.

Whilst a longer shot, we think that the likes of Microsoft and Yahoo could be interested in TripAdvisor. For Microsoft, it would be a nice complementary asset to Bing, helping it gain market share in online search in the travel business. For Yahoo, it could be a powerful source of content to offset the constant market share erosion they suffer in search.

Key risks and overhangs

Google Disintermediation - In November 2010, Google launched a competing product called Google Places. At the time, it was perceived as a significant threat to TripAdvisor. Google Places when launched diverted significant traffic away from TripAdvisor. TripAdvisor complained because a) Google was using TripAdvisor’s content (i.e. reviews from TripAdvisor website) including third party review synopses in its results, and b) Google Places would show up above TripAdvisor in organic searches which made no sense given TRIP’s popularity. If the reader now tries to search in Google “Hotel Review New York”, he or she will find 2 interesting results: a) TripAdvisor appears above Google and, b) Google Places offers only Google reviews, so its content is by far inferior to TRIP’s content. It appears that Google rectified its original strategy and backed down, this happened approximately in July-August 2011. This is a proof of TRIP’s superior content and if anything it shows that TRIP is a formidable asset that could be a likely target for Google.

Expedia - Another market concern is the fact that Expedia is a very large client of TripAdvisor. In the last 12 months, Expedia represented c. 25% of TRIP’s sales, or c. $150m. The concern is that after the 1 year agreement following the spin-off, Expedia, not owning TRIP anymore, will purchase fewer services from TripAdvisor. Whilst this is a real concern, we believe that Expedia will continue to invest heavily in marketing going forward so even if on the margin it may reduce purchases from Expedia, this should not be material. TRIP should not have much trouble in replacing eventual lost business from Expedia with other OTAs.

Downturn - Finally, travel is obviously very cyclical and many investors shun away from travel businesses as we are heading for global slowdown. We would just point out that in 2009, with global GDP down 2.5% and US GDP down 3.5%, TripAdvisor sales still rose almost 20%.

Summary investment recommendation

TripAdvisor is a unique asset benefitting from strong secular tailwinds, exposed to the hottest “themes” in the market, i.e. online penetration, online advertising monetisation and social media. TripAdvisor enjoys significant barriers to entry that enables it to earn 50%+ EBITDA margins. As such, it is a premium asset which we believe could be a takeover candidate for the likes of Google, Microsoft and possibly Yahoo. Such premium asset is in our opinion undervalued due to concerns of disintermediation risks associated with Google and general macro concerns of travel slowdown in 2012. Trading at less than 8x EV / EBITDA 2013E, we see substantial upside as more investors become familiar and comfortable with TripAdvisor story.

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