Description

While a unique setup, TRVG checks a lot of the same boxes as many other fund’l value disconnects that we’ve found ourselves involved in over the years:

1/ Broken IPO now largely ignored (-55% from pricing and -80% off highs; now firmly in the five o’clock or “forgotten”/”dog” area of the earnings expectations lifecycle)

2/ Skepticism around core value proposition (travel metasearch specifically hotel-only discovery)

3/ Increased competitive worries (fluid category dynamics including specter of GOOG)

4/ Overhang from risk factor that’s already been realized (BKNG/EXPE customer concentration)

5/ Uncertainty/skepticism around top-line trajectory (1H18 -13% vs +56% pre-IPO 2-yr CAGR)

6/ Uncertainty/skepticism around model’s profitability (€92M 1H18 cash burn vs articulated 25%+ LT adj EBITDA margin target and LSD cap ex % of revenues)

7/ Lack of mgmt credibility owing to poor public track record despite strong pre-IPO achievement (multiple misses off bar set too high, driver behind downward fund’l spiral outside mgmt control)

8/ Low expectations/poor sentiment (Street est’s appear overly pessimistic; 22% of float is short)

9/ Over-looked optionality (high insider ownership, consolidating category where ever-increasing scale and distribution reach are strategic imperatives for largest players)

Issues notwithstanding, this appears to be a much better business than what the market is currently discounting. Variant view suggests current combo of stable auction dynamics, cycling of bid-down activity that was primary cause of fund’l decline, efficacy of recent strategic pivot to profitability and improved execution against expectations/guide should diminish market’s overly pessimistic stance and allow gap to estimated intrinsic value to narrow.

Upside potential more than 2x on improving visibility on both profitability of existing revenue base and eventual return to top-line growth in line with large-OTA room-night growth with upside potential from any OTA partner shift back to growth, increased penetration of alt accommodations, greater supplier-direct penetration, and/or improving value prop on rate-parity changes and increasing customer preference complexity.

Margin of safety is combo of discount to estimated intrinsic value, high insider ownership (EXPE 60%, founders 30%), €100M net cash position and material strategic/scarcity value in consolidating sub-sector within online travel (TRVG trades 1.4x 2018 revenues while precedent metasearch transactions average ~6x and TRIP’s comparable Hotel segment appears to command 3-4x).

Key Investment Considerations

Metasearch channel consumer/supplier value proposition remains robust and TRVG's hotel-only product/positioning/relevance remains strong and under-appreciated by Street. While LT impact of OTA customer ownership and increasing consolidation is open for debate, metasearch is likely to remain an important customer acquisition channel for the foreseeable future. For OTAs metasearch is likely a more productive channel than paid search, retargeting, display, and email. And increasing purchase complexity including increased penetration of alt accommodations and shifting pricing standards appear set to further improve consumer utility. Moreover, recent OTA consolidation activity in the space appears to be a vote of confidence in the future of the channel.

TRVG’s has a demonstrated ability to acquire quality traffic as evidenced by its ability to rapidly scale with the two largest, most-sophisticated OTAs as its primary customers. Competitive strengths include global reach, strong product capability and high brand awareness. Additional positives include 1/ LSD penetration of $55B worldwide travel ad market; 2/ attractive int'l positioning (better markets than US i.e. more fragmented, faster growing, weaker GOOG threat); 3/ organic traffic - shielded from SEM/SEO challenges/GOOG, 85% of organic search traffic from branded searches, ~70% of shoppers use a search engine to start travel planning process; 4/ healthy unaided brand awareness and clear brand message (go-to destination for hotel booking vs TRIP go-to destination for planning/researching); and 5/ strong mobile monetization with >60% mobile mix and single bidding structure for desktop and mobile.

Focused, hotel-only positioning is an advantage as singular focus allows for continuous innovation and ability to be nimble and hotel category offers superior economics. Also believe TRVG can compete w GOOG which has more horizontal orientation by being nimble and innovating (small and focused can succeed vs large and unfocused). And global hospitality is a large market opportunity where zero-sum arguments have historically proven mis-placed.

Auction dynamics stable and BKNG/EXPE customer concentration a business reality that reflects current industry structure (BKNG and EXPE were 44% and 36% of revenues in 2017 and 38% each at 2Q 2018). But value prop, importance of meta channel and auction stability suggest bid-down activity that drove downward revision cycle has run its course. Believe BKNG has reached status quo based on bids that reflect attractive single-transaction ROIs vs prior adjustments for potential repeat, lifetime value, etc. BKNG could continue to underwrite auction volatility with further ROI changes but mgmt has strategic rationale to drive greater scale and likely welcomes transaction-ready leads that provide attractive single-transaction ROIs. Also suspect BKNG welcomes TRVG’s shift to "playing by the rules" and having to generate profitability.

Visibility on profitable, highly capital-efficient underlying model set to improve. This is a low fixed-cost ad business with near-100% incremental margins. Nonetheless, skepticism around efficacy of recent profitability pivot abounds and primary fund’l risk is top-line is more materially negatively impacted from spending pullback/optimization than expected. Optimistic stance supported by business model/expense structure, high existing awareness and favorable traffic mix, TRIP Hotel segment optimization precedent/current profitability and favorable impact of attribution model/website optimization that should become more visible starting in 3Q.

Mgmt’s articulated targets including ad expense <65%, ROAS >155%, fixed costs 10% and EBITDA margins >25%. This 25% EBITDA margin target appears to be just a start and model should support 35%+ EBITDA margins. Albeit not perfect, as a proxy TRIP’s Hotel segment is expected to support 25% margins and generate $300M EBITDA in 2018 and the segment’s margins peaked in high 40s.

High awareness especially in Developed Europe, favorable traffic mix and massive overall amount of direct ad spend (€884M ad spend in 2017 or 85% of revenues) suggest material opp’y. Mgmt has implemented return hurdles that we suspect have revealed significant sub-optimal spend. And current testing/learning process to uncover efficiencies is something they couldn’t do in past given risk associated with high-growth hurdle and cultural mindset that every extra euro should be spent against growth regardless of return.

Comp TRIP began optimizing spending in earnest in 4Q17 and even recently has been bullish about its ability to continue to find efficiencies and optimize spend. Through 3Q 2018 TRIP’s estimated TTM direct S&M spend is ~$610M -6% y/y including $125M of TV spend that is estimated up >100% y/y. Allocating 80% of total to Hotel and excluding TV spend, TRIP’s TTM Hotel segment performance spend is expected to decline close to -20% or nearly $100M to <$400M vs $475M in year ago TTM period. Meantime, estimated TTM CPC-based revenues are expected -7% including a -HSD% decline rev/hotel shopper from partner bid downs that commenced 2Q17. TRIP’s total estimated TTM Hotel direct spend is 71% of CPC revenues vs TRVG’s 2Q18 TTM consolidated ad spend at 89% of total revenues (€853M of total ad spend and optimization started mid-way through 2Q). Like TRIP’s initiatives to improve traffic quality, suspect Street also under-estimating positive impact of attribution model and website optimization (improved traffic quality double digits) that will become more visible in 3Q and beyond as bid downs lap.

Visibility on eventual return to top-line growth should improve on cont’d stable auction dynamics, lapping initial bid downs, positive impact of attribution and website optimization efforts and eventual lapping of spending pullback/optimization efforts. Reasonable to expect slower rates (i.e. in line with large-OTA unit-growth of +LDD). Longer term, metasearch tailwinds including incorporation of alt accommodations, elimination of rate parity provisions and improving relative value vs paid search suggest potential for return to faster top-line growth. There is also the potential for OTA partners including BKNG to shift back towards growth/share mode in response to changing industry dynamics (EXPE’s int’l inventory acquisition program, CTRP's push outside China are examples).

Execution against reasonable expectations should lift mgmt credibility off current lows. In retrospect, coming public on hyper-growth numbers was a mistake especially as impact of implementation of a major change – the attribution model – was uncertain and subsequent 1H 2017 commercialization benefits proved transitory. But historical put/call relationship with EXPE did likely constrain timing flexibility. Nonetheless, mgmt deserves blame here. More recently, disruption from BKNG's bid-down activity was out of their control but also in retrospect it could be argued they were too slow to adapt to this environmental shift. Regardless, they appear to be on the right path now. Mgmt now seems to clearly understand how credibility deteriorated and why they aren't getting any credit for recent strategic shift despite the model’s structural profitability potential. Focus now is to re-establish credibility by delivering results and meeting/exceeding expectations.

Optionality offers additional margin of safety. As major player in consolidating sub-sector within online travel strategic/scarcity value seems under-appreciated. Metasearch has been consolidating and five meta platforms (GOOG, TRIP, TRVG, BKNG/KAYAK and CTRP/Skyscanner) will likely to prove too many over the long haul. EXPE has been supportive independent shareholder and doesn’t appear to be keen to do anything with its stake especially at current levels. Longer term could do tax-free spin like TRIP but highly unlikely anywhere near current levels. Nonetheless, multiple precedent metasearch transactions done on average at ~6x LTM revenue also suggest material public-market disconnect vs TRVG at 1.4x (TRVG at IPO 4.0x). Even recent $550M BKNG for Momondo deal (sub-scale, European-centric, air-based platform) at ~3x LTM revs implies TRVG value of up to $10/ADS.

Background/Source of Opp'y

TRVG is Dusseldorf-based, hotel-specific metasearch platform (almost entirely auction-based CPC model) that is 60% owned by EXPE and 30% by founders. Functional currency is euro. Business scaled rapidly (+56% pre-IPO trailing 2-yr revenue CAGR) on strength of search product (differentiated based on streamlined user experience, single-mission focus in key hotel category) and heavy re-investment cycle whereby virtually all growth was plowed back into business to facilitate brand-building (~50/50 TV ad and perf-marketing spend) and geographic expansion (revenue mix 42% Developed Europe, 38% Americas and 20% Rest of World). Despite growth focus, achieving scale required almost no outside capital.

TRVG has reached requisite scale and geographic scope (1.8M hotels, 55 countries, 33 languages), functional currency is Euro and business carries no debt (EXPE guarantees any indebtedness). In April filed mixed shelf including $500M primary and all 111M Founders shares (stock $6.50/ADS on Apr 4) with mgmt indicating secondary piece done out of expediency.

EXPE bought 62% in Dec 2012 for $632M (implied $1.03B value) primarily from early-stage investors. Founders own 30% and employees have monetized little equity. TRVG priced 30M-ADS (including shoe) IPO in Dec 2016 at $11/ADS (downsized slightly; priced below initial $13-15 range) that resulted in 9% of company floating. Stock subsequently doubled to low $20s by exceeding initial expectations before being initially cut in half in 2H 2017 on largest-customer BKNG raising ROI thresholds that negatively impacted revenue growth and thus incremental customer acquisition capability (incremental ad spend). Stock was essentially cut in half again following further changes/volatility in 3Q 2017 and at 1Q 2018 with latter including material profitability guide down from "EBITDA margins slightly lower" to loss (€50-25M).

TRVG initiated a strategic shift to profitability in 2Q in response to “new normal” economic landscape and desire to return to historical self-funded business trajectory after sizable 1H cash burn. In conjunction with pivot, revenue guide was lowered to “flat” to “decline” while adj EBITDA was raised from loss (€50-25M) to loss (€30-15M) and Street consensus (€25M). Guide implies 2H profitability of €10-25M. Particularly bullish on 4Q profitability as seasonally least important advertising period where prior to IPO TRVG would naturally pull back spend owing to combo of crowding out and higher ad rates. Most recently, HF PAR capital agreed to acquire 7M ADRs at $4.47 from two founders in a privately negotiated deal (PAR will own 13.1M shares or 35% of float).

Potential Catalysts

Better execution specifically against recent profitability pivot

Improved visibility on eventual return to growth

Rehabilitated credibility on delivering against guide/Street expectations

Upward estimate revisions, upgrade cycle, short-squeeze exacerbated by low float

Business combination

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Catalyst

Better execution specifically against recent profitability pivot

Improved visibility on eventual return to growth

Rehabilitated credibility on delivering against guide/Street expectations

Upward estimate revisions, upgrade cycle, short-squeeze exacerbated by low float

Business combination