Description

eDreams (EDR) is a leading flights online travel agency (OTA) in Europe with a #1 or #2 share in key European markets. EDR has a presence across 46 markets covering ~80% of the total travel market. The company operates 5 brands acquired via rolling up the European OTA industry.

Background

Company History

eDreams was founded in 1999 by Javier Perez-Tenessa, James Hare and Mauricio Prieto with venture capital firms from Europe and the United States. In 2006, EDR was acquired by TA Associates for €153m via an LBO. Private equity firm Permira then acquired the company in 2010 via another LBO valued at €350m. In 2011, Permira and AXA Private Equity acquired Opodo (another European OTA) from Amadeus in a deal worth €450m. Opodo was combined with GO Voyages (owned by AXA) and eDreams, which collectively formed eDreams ODIGEO.

EDR completed its IPO on the Madrid Stock Exchange in April 2014 for €10.25 per share (€1.5bn valuation). The company immediately faced challenges as Google changed their SEO algorithm functionality toward keyword bidding which caused the company’s margin to compress. In October 2014 EDR’s stock fell substantially after Iberia Airlines and British Airways said they would no longer market tickets with eDreams due to issues around price transparency. The stock ended 2014 at €1.68/share.

Current CEO Dana Dunne was then appointed in January 2015 to execute a turnaround of the business. Dunne began by integrating the multiple backend platforms that made up the eDreams Group to create one unified platform. The new management team also focused on diversifying its product base, offering more transparent pricing to customers, and improving its tech lead vs. competitors. Additionally, the company sought to simplify the European travel market by introducing a subscription platform (Prime).

In November 2017 the company announced that it would conduct a strategic review, including a potential sale process. The decision was prompted by unsolicited indications of interest from potential investors. The review was concluded in March 2018 as the Board deemed bids insufficient. 

The company has successfully turned around the business under the helm of Dunne and valuation shouldn’t be anchored to pre-pandemic levels as the business is well placed to gain further share and drive earnings growth. 

Holder base

Free float is ~48% of shares outstanding. 

Liquidity

Given the largely variable cost structure (i.e. 4Q’20 revenue margin declined 17% while variable costs declined 23%) and temporary fixed cost and capex reductions the company has been able to weather the pandemic with its existing credit facility. The company is cash flow breakeven at bookings volume 50% lower vs. 2019

Investment Thesis

EDR is an above average OTA trading at a below peer average multiple. A broken IPO and execution issues in the past have weighed on the stock over the years but I believe those issues are well behind the company. I think the stock first re-rates once bookings growth returns as Europe re-opens with EBITDA margin expansion as customer acquisition costs trend lower. Direct customer traffic is the holy grail for an OTA and structural aspects of the European travel market in conjunction with the company’s increasingly diverse revenue base and Prime subscription program all serve to increase EDR’s revenue share via this channel. 

Scale/tech advantage makes the flywheel turn and widens EDR’s moat. The company has a leading market position in Europe and likely gained share through the pandemic

In the €15bn European online flight market (in terms of gross bookings) eDreams holds a leading market share of ~32%. EDR has steadily increased its lead vs. competitors over the years as 2016 market share was 27%.  The charts below compare EDR bookings growth vs. IATA market data and suggest EDR was likely outperforming the broader European air travel market through the course of the pandemic.

Flywheel: The more scale an OTA has the better pricing/incentives it can get from suppliers which leads to more bookings and higher margins which then allows for further investments in product/technology/marketing. These investments create a better product/user experience which then attracts more customers and drives further scale leadership.

Tech investment: Early on CEO Dunne realized the importance of mobile and a strong tech platform to drive a superior customer experience that drives repeat direct business. EDR employs over 400 engineers vs. an average of ~30 across other regional European players resulting in faster product innovation.

Mobile as a % of flight bookings has steadily increased over the years (18% in 2015, 40% in June 2019, 58% in December 2020). This is hugely valuable as mobile users don’t benchmark prices - meaning you truly own the customer relationship if they choose to use your app on an ongoing basis - which in turn translates to higher margins given low/zero CAC. It is also worth noting that Europe is not a homogenous market - countries have different payment mechanisms, require different marketing approaches, etc. That EDR has a leading share across all major countries is a product of investing in the right tech and systems integrations over the years and creates a barrier to entry. While etraveli and Expedia (#2 and #3) are larger companies with more resources to compete, there are plenty of smaller, under-capitalized players in the space that EDR has been taking share from.

Scale and significant tech investments have translated to EDR being the low-price leader for flights with surveys showing EDR pricing below that of airlines and OTAs in 90% of European flight searches. 

Characteristics of the European flight market (high fragmentation, more connecting flights) increase the value proposition OTAs provide to the end consumer

The US has 58 airlines, with the top 4 commanding 81% market share whereas in Europe there are 224 airlines and the top 4 players have only 29% share. Additionally, brand recognition for airlines in the US is high whereas in Europe the customer tends to be more brand agnostic. Finally, the European flight market is characterized by a greater number of multi-legged segments and lower concentration of flight routes. On average EDR has 8 more flights per day and route than airlines offer on their websites directly. Given the differences in markets, US OTAs earn a 2-3% take rate on flights vs. ~9% for EDR. Compared to meta sites (aggregators such as Kayak or Skyscanner), EDR has developed all the tech to allow customers to transact directly on their site, making the booking process faster and simpler. 

Diversification of revenue stream beyond flights

Over the years EDR has leveraged their flight advantage to increase non-flight sales including hotels and a number of ancillary services (insurance, seat selection, luggage, etc.) in order to gain a large share of total customer travel spend. Data collected from flight bookings gives the company an edge vs. hotel-based OTAs (more personal info required to book a flight vs. a hotel) allows the company to better cross-sell other products/services. As seen in the charts below,  Diversification Revenue (i.e. all the non-Flight revenue) and the number of products sold and attach rate has increased significantly over the years. As of December 2020, Diversification Revenue was 53% of total revenue. This revenue is in part higher margin because Hotels garner a higher take rate vs. flights and also because the sales incur no additional acquisition cost given it’s a pure upsell following a flight purchase. Growth in ancillary sales is also due in part to the company’s best in class tech. Sourcing and offering multi-airline seat maps, for example, is difficult from a technical standpoint and EDR was one of the first to implement this.

Prime membership: strong customer proposition + lowers CAC for EDR and significantly increases customer LTV

Prime is a subscription service for travelers.

Customer benefits: For €55-60 per year customers receive discounted prices on 100% of flights, lodging discounts, and priority customer service assistance with top agents and faster pick up time. 90% of the time Prime ticket prices are cheaper than any other offer in the market. This is possible because Prime bookings incur a lower customer acquisition cost and EDR can reinvest these savings toward lower prices. 

Company benefits: Versus a non-Prime member, Prime customers are more engaged (+50% increase in visits), have a higher conversion rate (+100%), book more frequently, have lower customer acquisition costs, and present an easier cross-sell opportunity for accommodations which has a higher take rate. In sum, this translates to Prime customers having a much higher LTV than that of a non-Prime customer. On a 12-mth horizon Prime members are 2.3x more profitable, 3.6x on a 24-mth basis, and 4.4x on a 36-mth basis. The benefits of Prime will likely scale up as the subscriber base grows and inflects.

Prime membership has grown from 25k in June 2018 to 1.2m in June 2021 and 1.5m as of August 2021. The company added 200k subscribers from April through December 2020 (+71% and +55% y/y in 2Q’21 and 3Q’21) in the midst of the pandemic and minimal travel. That customers subscribed for the service during a period of severely curtailed traveling underscores the inherent value proposition. The most recent quarter (June ’21) saw growth accelerate, as global economies began to reopen, with 340k net adds q/q (+39%). Prime members currently account for 39% of bookings (versus 6% 2 years ago).

Prime was developed and refined over several years via an iterative process incorporating 50k in-depth customer interviews and thousands of A/B tests. Given this development phase and EDR’s brand recognition, it’s not a simple matter for a competitor to come in and launch a similar offering.    

The company was initially targeting 2mm subscribers by 2023 however this target has since been pushed forward to 1H’22. This would represent 110m of revenue, or ~20% of pre-Covid revenue. The company is reinvesting this revenue to lower customer prices. This investment has a massive ROI as it allows EDR to own the entire customer relationship, drive CAC down via repeat customer bookings, and increase market share. 

Declining customer acquisition costs

Executing on all the aforementioned strategies (developing leading tech/consumer experience, diversifying across other travel products, and growing the Prime subscription business) coupled with structural aspects of the European market, has driven acquisition costs per booking down significantly since 2015. CAC at December 2019 was 36% lower versus FY’15 (December 2020 level in chart below is to some extent artificially low given the pull back in marketing spend)

Historically a knock against OTAs has been that they are beholden to search engine (i.e. Google) results and gaining share requires continued spend on paid search and performance marketing. EXPE earnings, for example, show direct marketing expense increases closely track increases in bookings growth. Of course, some traffic will always have to flow from Google paid searches, but the goal of every OTA is to minimize this dependence as much as possible as direct customer traffic (website/mobile) or organic search traffic (i.e. not paid) is the primary way to drive margin expansion given the largely variable cost model. EDR EBITDA margins have expanded from 17% in FY’15 to 21% in FY’20 (March ’20, which was partially Covid impacted). 

FY’20 Earnings Call: “We are the flight OTA with the highest branded average monthly queries on Google in all European countries, which allows for a very effective capture of customers end demand and resiliency. And our scale advantages make us both a better partner and less reliant long-term on the metasearch versus competitors.”

Valuation & Price Target

I model EDR achieving €170-200m of EBITDA by FY’24 (March ’24), a ~6-10% CAGR versus FY’20 EBITDA adjusted for the impact of Covid (€135m). OTAs have historically traded at 12-18x a normalized EBITDA versus EDR trading at just 6.5x assuming 175m of EBITDA. Given EDR’s valuable subscription platform it should arguably trade at the high-end of the peer multiple range, if not a premium. That said, even a valuation re-rate to the low-end would generate considerable share upside. A 12-16x multiple range on €170-200m of EBITDA results in a target value per share of €14-24 or ~90-225% upside from current levels (30-60% 2Y IRR). Signs of pent-up demand for leisure travel showed up in the numbers in the most recent quarter when the company reported bookings growth versus 2019 of +2%, +6%, and +27% for June, July, and August 2021 respectively.

PE holders have been invested in the name for over a decade now. It’s possible the stock could re-rate to a full valuation over time and allow for a public markets exit or alternatively an acquisition by a strategic would allow for a more swift exit. Transactions have historically occurred at 13-15x EBITDA.  Potential acquirers include Expedia, AirBNB, Google, CTrip, among others. 

Catalyst

Rebound in leisure travel, EBITDA growth