Volcanic ash. A European economy on the precipice. Riots in Thailand. Online travel agency Priceline.com deftly flew through all of it, outdistancing peers yet again.
Since 2007, Priceline stock is up more than 400%. Nearest competitor Expedia is up just 10%, while smaller rival Orbitz Worldwide has seen its shares decline 70%. Travelocity is closely held.
Why the stunning outperformance? Though Priceline is famous for letting you “name your own price” for airline tickets, most profit actually comes from selling European hotel rooms. There, Priceline maintains a big lead, thanks to clever acquisitions and a unique business model.
In 2005, Priceline picked up Netherlands-based online hotel site Booking.com, now the backbone of its international business, for $133 million. In the second quarter alone, Priceline generated $322 million of gross profit internationally, 69% of the company’s total.
Fragmented markets are where intermediaries can add the most value and generate the most profit. While there may be a handful of airlines that can get you from Point A to Point B, Point B has dozens of hotels to choose from. So while airlines pay a few dollars in commissions for each booking, hotels pay about 15% of the room rate.
While Expedia bests Priceline in gross travel bookings, Priceline sells more hotel-room nights—23.2 million in the second quarter against Expedia’s 20.3 million. Second-quarter operating margin for Priceline was 39% versus 23% for Expedia. Orbitz sells mostly airline tickets, so badly lags behind the other two.
Europe is particularly lucrative due to its higher percentage of boutique hotels, as opposed to the chain-heavy U.S. The growth opportunity is also better. Only 17% of European hotel bookings are made online, says PhoCusWright, compared with 29% in the U.S.
The good news for Priceline is that it may be able to maintain its big European lead. The way it charges for each booking has a worse cash-flow profile than Expedia’s, but it is more attractive to the hotels themselves. That helps Booking.com lock up inventory. More customers and more inventory creates a network effect not unlike eBay’s in the auction business, a sturdy barrier to entry.
Yet Priceline’s premium valuation should still give investors pause. At about $295 a share, the company is valued at a steep 18 times analysts’ estimate for 2010 earnings before interest, tax, depreciation and amortization. Expedia trades at just seven times. Priceline’s focus on high-margin hotels and faster-growing Europe certainly makes it more attractive, but the frothy level leaves investors little margin of safety if, for instance, a double-dip recession smacks travel.
The rising tide of travel booked online will lift Expedia, too. Its big discount relative to Priceline may make it the better long-term bet.