Is Online Travel Amazon's Next Stop?

We see wide-moat Amazon’s AMZN announcement that it is offering domestic flights within India as a potential precursor to the company developing a metasearch platform (not an online travel agency, or OTA, model approach), which could have negative long-term financial implications for narrow-moat TripAdvisor TRIP, with a more negligible financial impact on narrow-moat OTAs Booking Holdings BKNG and Expedia EXPE. Expedia shares appear attractive, trading at a meaningful discount to our $183 fair value estimate.

Amazon has had several travel-related pilots in the past. The previous test was in 2014, when the company offered a limited number of hotels before canceling the venture in 2015. While Amazon has not disclosed the reasons for not moving forward with that travel initiative, we believe it is in part due to the significant time and cost needed to aggregate and service supplier relationships, which is what OTAs Booking and Expedia have developed over the past 20 years. Our long-held view has been that if Amazon decided to add travel to its platform, it would adopt the metasearch model, like that of Google GOOG/GOOGL and TripAdvisor, which depends on OTAs to place and power those aggregated supplier relationships on its platform. The India air announcement is in line with this view, as OTA Cleartrip is powering the relationship.

Should Amazon move forward with a full metasearch travel offering, it would become a more direct competitor to around 75% of TripAdvisor’s total revenue that is exposed to the metasearch model. While we await more details from Amazon India, if we were to reduce our 10-year TripAdvisor metasearch revenue forecast toward 5% annual growth from 6% (for traffic share loss to Amazon) and increase our 10-year marketing spending as a percentage of sales toward 48% on average from 47.5% (for higher customer acquisition costs), it would reduce our $59 fair value estimate by $3 per share.

The risk to Expedia and Booking would be more manageable and negligible to financials, in our view. An Amazon metasearch platform would represent an additional indirect channel to Expedia and Booking, requiring more marketing spending if it were used heavily by travelers. An offset would be the OTAs’ ability to drive direct traffic, which both have successful done despite the increasing presence of Google’s metasearch platform over the past few years.

Network Effect Drives Moat We see Expedia as having a narrow moat driven by its sustainable network effect in the online travel industry. Over the past two decades, Expedia has built a strong network of properties (supply side of the network effect equation), which has driven strong end-user traffic and bookings (demand side of the network effect equation). At year-end 2018, the core Expedia platform had over 1 million properties (including 370,000 HomeAway vacation rentals). On the demand side, as measured by App Annie on May 2, Expedia's core platform ranks as a top-10 travel iOS mobile application in 21 countries versus 128 for Booking.com and 18 for TripAdvisor.

As a result of the strong network effect, Expedia and Booking each have around 35% share of the global OTA booking market. Beneath these two, share is highly fragmented, making it extremely challenging for smaller new entrants to gain customer traffic and supplier scale. Smaller new entrants would need substantial human capital to build relationships with hotels and gather crucial information and pictures from those hotel properties. They would also need to spend heavily on advertising to attract customers to the website, and any customers obtained would require IT, data center, and 24/7 customer support to retain. Expedia is able to advertise well in excess of competitors, which helps drive its network advantage. In 2018, Expedia spent $4.7 billion on direct marketing (42% of total revenue), while we estimate Booking spent nearly $4.9 billion in 2018 (34% of total revenue); in comparison, number-three player Orbitz spent $334 million on advertising in 2014 before it was acquired by Expedia in 2015. As scale is built, understanding of consumer behavior also increases, which leads to improved customer experience and conversion.

Our narrow moat rating is further justified by the company’s return on invested capital and market share gains. We project return on invested capital (including goodwill) to average 21.7% over the next five years, comfortably above the company’s 8.5% cost of capital. We forecast Expedia’s market share of global travel bookings to reach 7.7% in 2023, up from 6.5% in 2018.

Despite its returns on invested capital, we don’t believe Expedia has carved a wide moat, given potentially meaningful competition beyond the next 10 years from new entrants that already have the customer traffic and budgets to build network scale, including Amazon, Google, Facebook, TripAdvisor, and hotel consortia. Focused entry from these competitors would double the current handful of players that have dominant scale, leading to commodification of the industry and a meaningful impact on margins. That said, we expect the market to support some level of increased competition over the next several years, as the travel booking market remains large, at $1.7 trillion, and online penetration of the travel market remains low, at 45%.