TCOM - Despegar.com: A Profitable Rapid Growth Tech Trading At Only 1X Revenues

2023-11-24 05:47:15 ET

Summary

• Despegar is a rapidly growing online travel company that trades at a multiple way below peers such as Expedia, Booking.com, Make My Trip and Trip.com.
• Despegar has an unusually large number of catalysts that should lead to significantly higher revenues and earnings.
• The disconnect appears to be caused by past losses and a confusing income statement and balance sheet, which will be fully explained.

I started on this article about 3 months ago and set it aside twice. The reason was I had trouble understanding what was going on in both the income statement and balance sheet. Even the statement of cash flows was confusing. Unusual items included asset write-downs due to Argentine currency devaluation, semi-annual dividends, volatile tax rates, capitalizing website and software costs, a large related party liability, and large travel suppliers' payables. If I was confused, I'm sure many others are too. This may partially explain the large disconnect between the valuation of Despegar and its peers. After talking to management, I feel a lot more comfortable understanding the true picture. I hope after reading this article, you will too.

Background

Despegar.com (DESP) is the largest online travel company serving South and Central America and is based in Argentina. Its revenues are 52% from hotel bookings and vacation packages, 47% from airline, and 1% from financial or other. Its largest markets are Brazil 43% and Mexico 18% with Columbia, Argentina and Chile all about 13-14%. Despegar is 30% owned by Expedia. The majority of their competitors are smaller local players but they do compete with Booking.com in Brazil and Expedia in Mexico. Despegar claims to be either number 1 or a close number 2 in each of its primary markets, which include all those listed above and others like Columbia and Chile. It does compete with Booking.com but claims it looks at Latin America as more of a destination instead of an origination like Despegar does.

The company is not currently looking to move into new markets or business lines but is actively looking for acquisitions of smaller players in existing markets.

The company has a newer fintech business called Koin in Brazil which is a buy now pay later. This business had a negative EBITDA of $18 million in 2022. They expect breakeven in the second half of 2023.

Operating Results

The chart below shows earnings for the last 7 quarters.

Let's start with EBITDA. It's overstated and I don't recommend using it as reported. Despegar capitalizes is website and software development costs and includes them in capex. Capex was about $7 million last quarter and the prior-year quarter and most of that was for software and website. These costs offset amortization, making both a wash. In other words, most of the amortization in its EBITDA is from software costs, not acquisitions. So, if you use EBITDA, you should reduce it by the capex amount. This is what I did in the bottom line of the chart above. EBITDA is also before preferred stock dividends which are paid semi-annually. They total about $17 million per year and just over $4 million a quarter. The next chart deducts for dividends.

Despegar has not historically reported an adjusted earnings per share figure but plans to do so going forward. This may also have held investors back as earnings have bounced around. Like many travel companies, it has shown net losses since 2019. However, I believe on an adjusted basis they were profitable in the last two quarters and profits should accelerate. The last 6 quarters show a steady recovery in operating results.

The last two quarters' earnings fluctuated wildly due to taxes while revenues surged. In the most recent quarter, taxes were 103% of pretax net income. This was due to a high tax rate in Argentina. Management has guided for a 28% tax rate going forward. Management plans to show an adjusted net income figure starting this quarter. My estimate of adjusted EPS, using a 28% tax rate, was $0.06 in 3Q 2023.

Revenues in 3Q 2023 were $178 million, up 22% year over year, and all organic. Bookings in the quarter were up 25% in dollars. Actual transactions increased by 8% while the price per transaction increased by 16%. Higher pricing was primarily due to a shift toward more travel packages and international travel and to a lesser degree a higher take rate.

The second quarter of 2023 is usually their seasonally weakest quarter. Net income was $28.0 million or $0.25 per share, up from a loss of $0.26 one year earlier. However, net income in the quarter benefitted from two large one-time items both related to income taxes totaling $23 million. Excluding the one-time tax items I estimate EPS at $0.06. Revenues increased 23% to $165.5 million.

Business was particularly brisk last quarter in their largest market Brazil where transactions were up 28%. In their second largest market Mexico they increased 2%. Transactions declined 6% in their other markets. Declines elsewhere were primarily due to weakness in Columbia which appears to be stabilizing.

Not shown above is what they call "financial expenses" which are much of the difference between operating income and net income along with taxes. These totaled $3.2 million in 3Q 2023, $3.9 million in 2Q 2023 and $12.6 million in 1Q 2023. These have been $3-4 million per quarter, except for the period from 1Q 2022 and 1Q 2023 when they ballooned to $7-15 million. That increase was due to non-cash currency losses involving the write-down of assets in Argentina. Argentina has hyperinflation. Since Despegar fully hedges its currency, these are non-cash reductions in the value of assets mostly located in Argentina. They have now mostly written down those assets. Because of this, net income from 1Q 20022 to 1Q 2023 was significantly understated, and you really need to look at adjusted EBITDA and free cash flow (shown below). Since 1Q 2023, most financing costs are associated with the factoring of receivables in Brazil.

Free Cash Flow

This is an important section because if you just look at the income statement as printed it really doesn't give a clear indication of how the company is doing. Neither does Adjusted EBITDA. This is where I smooth it all out so you can see how Despegar is really doing. Several adjustments are needed to get to it, so bear with me.

It starts with Adjusted EBITDA as determined by the company and then I subtract capex, financial expense, dividends, and taxes. Capex is mostly capitalized software. For dividends, since they pay semi-annually I averaged linked quarters as described in the footnotes. For financial expense, the financial expense from 1Q 2022 to 1Q 2023 was significantly elevated due to a non-cash currency devaluation due to hyperinflation in Argentina. So, I used $3.5 million for 1Q 2022 to 1Q 2023. This was an average before and since that period. Since taxes have bounced all over, 28% of pretax income was used, as management has guided for that as a normal rate. The bottom line is called Adjusted Free Cash Flow. It is a much better indication of operating results than net income or adjusted EBITDA. It shows a very positive trend and recent strong results.

Financial Results last 6 years

The table below shows financial results back to 2 years before the pandemic.

Despite the overall travel market in Latin America just now coming back to pre-Covid levels, Despegar's revenues in 2022 exceeded 2019. They should be well above 2019 this year.

On November 9, 2023, the Company increased its 2023 annual guidance as follows:

Revenue: from $640 - $700 million to $670 - $700 million Adjusted EBITDA: from $80 - $100 million to $90 - $100 million

This indicates the company expects revenues of about $183 million in the fourth quarter of 2023 at the midpoint. That's up 26% to 4Q 2022 and well above pre-Covid.

Balance Sheet

Like the income statement, the balance sheet requires some explanation.

There is a $125 million related party liability. It is owed to Expedia but only if Despegar breaks off their contract where Expedia sources all hotel and airline data from Europe and the U.S.

Travel suppliers payable of $370 million on September 30, 2023, is better described as customer deposits. Most of it is what customers paid for airline tickets and hotel stays that haven't been forwarded to the providers yet.

On September 30, 2023, there was $174 million of preferred stock. Of that, $127 million has a 10% dividend. The other $47 million pays 4% but is also convertible at $9.25 per share. It will add 5.4 million shares once converted, which may be not far off. That's about 6.4% dilution.

Net worth was -$115 million and tangible net worth was -$363 million on September 30, 2023. Despite the large net worth deficit, the company had plenty of liquidity and little interest-bearing debt. Cash totaled $256 million and interest-bearing debt was $32 million. There are 2 primary reasons for this high net cash position. One is the high-level travel suppliers payable mentioned above. The other is the use of factoring instead of loans. Factoring is usually more expensive than loans so this may be a source of future expense reductions.

Catalysts

Despegar has an unusually high number of catalysts going forward that should significantly increase earnings. These are listed below.

1. Pandemic catch-up - Travel in Latin America is only now catching up to pre-Covid levels. There remains a strong tailwind of travel catchup, especially with international travel. Private airport operator, Corporación América Airports S.A. ( CAAP ) just announced October passenger traffic increased by 14.5% year over year. CAAP is primarily in Latin America. It said traffic is now 1.2% above pre-pandemic and the fastest increase is for international travel at 20.3%. Its stock has more than doubled over the last 15 months. Since economies are now larger after inflation and growth, there is still a way to go to get to the trendline pre-pandemic levels. Management believes international travel is still 10-15% below pre-pandemic, leaving a lot of runway for growth.

2. Market growth - According to Statista, travel is expected to grow close to 5% a year from 2023 to 2027 in South America. Despegar says the market growth will be more like 9-10% going forward. Travel growth prospects in Latin America are faster than in most developed economies and probably China. That gives it more upside than peers located there.

3. Online underpenetrated - Online travel booking in Latin America is well behind that in the U.S., China and Europe. CEO Scokin's comments from the November 9, 2023 conference call is as follows.

" Despegar is still in the early innings of capturing more of the past and underpenetrated Latin American travel market, providing us with a great deal of upside in the coming years."

4. Market share gains from struggling competitors - In August, Brazilian competitor 123 Milhas filed for bankruptcy. This was a substantial competitor based on its listed debts of $474 million. Despegar stands to pick up a lot of market share in Brazil, its largest market, from 123 Milhas. Another Brazil competitor is CVC. Its stock is down over 90% since the pandemic started and it is bleeding heavily. Its balance sheet is very weak. Their revenues are around $200 million a year, so this is another large potential source of market share gains.

5. More profitable mix - Revenues increased 24% last quarter from the prior year despite an only 8% increase in transactions. This was due to a shift to higher-priced packages from hotels and airfare and more international travel. International travel is still below pre-pandemic. Despegar is emphasizing the packages.

6. Historical market share growth - Revenues have grown much faster than local peers. For example, CVC mentioned above had flat revenue growth this year and is well below pre-Covid. The market as a whole is approaching pre-Covid while Despegar is guiding for 30% above 2019 revenues this year. Despegar has done this by gaining market share due to its scale versus most competitors. It continues to have that advantage.

7. Expedia support - Despegar is 30% owned by Expedia which provides listings of hotels and airfare outside its market area.

8. Argentina's new government - On November 21, 2023, Javier Milei was elected president of Argentina after promising to take a chainsaw to government spending. Since the spending has been the primary cause of economic malaise and hyperinflation, the Argentine markets rallied powerfully. But Mr. Milei's party only controls 14% of the legislature, so changes may be difficult. If nothing else there should still be a change in spending direction. Argentina is Despegar's home market accounting for 14% of revenues.

9. Loyalty Program - In the most recent quarter, loyalty program members increased 194% YoY to 16.9 million. This number increased to around 20 million as of the conference call 2 weeks ago. This should further help take share from smaller competitors.

10. Earnings leverage - Earnings should increase more rapidly than revenues assuming continuing revenue growth. This is because Despegar is a low capital-intensive business with an already built-out infrastructure. Management has guided 20% annual revenue growth going forward. Earnings should grow more rapidly than that.

11. Koin - This is a newer buy now, pay later business which has been running large losses. EBITDA was -$18 million in 2022. It is now close to breakeven and is expected to be moderately profitable going forward. Koin is only in Brazil and is more of an enabler than a profit center.

12. White label solutions - This is one of their fastest operations growing at twice the rate of the company as a whole. White label is a B2B2C business. That means Despegar is essentially a private label and enabler for others to offer travel services. It provides the software, websites and processing for others in their customer's name. This segment is now 8% of total revenues and adding more customers.

13. Vacation rentals - The company expanded non-hotel properties listed on their service by 45% over the past 9 months. During the last quarter, they partnered with VRBO which will add a lot more properties. Total properties listed increased from 400,000 to 750,000 over the past year. This is expected to increase to almost 1 million with VRBO.

14. AI Travel Bot - Despegar just introduced a Beta version of its AI trip planner in Argentina. In a conversational way, it will offer travel and accommodation recommendations.

Concerns

Every company has issues that investors should be aware of. Here are my concerns with Despegar.

1. Not easily bought - Expedia's 30% ownership makes it difficult to be acquired by anyone other than Expedia. I believe without this shareholder, they probably would have been sold by now. This is based on Despegar's huge discount to peers shown in the next section.

2. Negative tangible net worth - Tangible net worth was -$363 million on September 30, 2023. Despite this, the company is quite liquid. Cash totaled $256 million on that date, well above interest-bearing debt of $32 million. The reasons for this high net cash position are the high level of travel suppliers payable and the use of factoring instead of loans. Keep in mind there is the $125 million related party liability that may never need to be paid but it reduces net worth.

3. Possible recession - Economies around the world are slowing and are expected to slow further in 2024. Consumer travel is over 80% of their business and is mostly discretionary. The two largest markets served, Brazil and Mexico, have relatively strong economies right now.

4. Increased competition - Despegar enjoys a relatively lower level of competition than most companies from competitors their size or larger. Expedia is a part owner so does not compete except in Mexico. Booking.com does compete but looks at Latin America as more of a destination than origination according to management. The biggest risk here is Booking.com gets more competitive. Also, other larger players such as Trip.com ( TCOM ) could move in.

5. Debt levels are understated - The company uses factoring to fund current assets instead of a line of credit. This is usually a more expensive form of financing.

Valuation

Despegar was compared to other larger online travel companies in the chart below.

As shown above, Despegar was less profitable than all of its peers in its most recent fiscal year (calendar 2022). However, it has recently turned profitable. It also has higher leverage as it is the only one with a negative tangible net worth.

On the other hand, Despegar has a price to revenues well below all peers. It also has a higher growth rate than all but Booking.com ( BKNG ). It has a higher potential growth rate than all except possibly MakeMyTrip ( MMYT ) going forward as it is in higher growth markets and much farther from maturity than all but MakeMyTrip.

In my opinion, Despegar is most comparable to MakeMyTrip, which is its equivalent in India. I recently owned and made money on MakeMyTrip, it is a fabulous company. Like Despegar, MakeMyTrip just recently reached profitability. They are also similar in revenue size. Both serve large rapidly growing emerging markets. Yet MakeMyTrip trades at a huge premium to revenues versus Despegar. I believe part of that is warranted due to Despegar's higher leverage and slightly trailing in profitability. Tripadvisor would be the next best comparable due to size. Despegar should have a higher valuation than Tripadvisor ( TCOM ) and Expedia ( EXPE ) due to significantly higher past growth and future growth prospects. Based on the comps, I believe Despegar should be trading at 225% of prior year revenues. That is just above Tripadvisor and Expedia but well below MakeMyTrip. That indicates a market value of $1.21 billion or $15.71 per share. That is my one-year price target.

Takeaway

Despegar trades at a significant discount to its peers despite superior past revenue growth and future growth prospects. The company is growing faster than its market and has a large number of growth drivers going forward. Investors may have been put off by losses in the last 4 years and a confusing income statement. I believe a lot of the losses were due to Despegar trailing some of its peers in getting up to scale. But like MakeMyTrip, it is improving quickly and is now profitable. Losses appear behind them now and the value of this company will soon be apparent to many more.

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