2023-05-15 18:57:10 ET
Summary
- Booking Holdings is the market leader in the online travel agent (OTA) segment of the travel industry in terms of revenues and margins.
- Travel industry revenues are discretionary consumer spending. The segment is heavily dependent upon the health of the global economy and hence is cyclical.
- The COVID-induced community lockdowns devastated the revenues and profitability of the travel industry.
- Sector revenues have only just returned to pre-COVID levels, but at this stage, profit margins remain significantly lower.
- Bookings' current share price is currently well above my estimate of its intrinsic value and does not appear to be based on the looming global economic slowdown. It is time for investors to consider taking profits.
Company Description
Booking Holdings Inc (BKNG) is an online travel agency (OTA). The company was one of the first movers in developing an internet-based travel business to compete against the traditional shop-front travel retailers. Until February 2018 the company was known as the Priceline Group but changed its name and ticker symbol to better reflect the strength of its major brand (Booking.com).
Priceline is a well-known US brand but is little known throughout the rest of the world. The company was founded in 1997 by Jay S Walker. The company went public in 1999. The value of the company rose dramatically through the "dot-com" boom earlier this century but it suffered the same fate as many other internet companies when the "bubble burst" in 2002. During the dot-com bust the price of the stock went from a high of $1,000 to a low of just under $7 per share.
Bookings has grown over the years both organically and by acquisition (generally relatively small). The key acquisitions include:
- Booking.com in 2005 (total cost $133 M).
- KAYAK Software Corporation in 2013 (total cost $2,100 M).
- OpenTable in 2014 (total cost $2,500 M).
- Cheapflights in 2017 (total cost $555 M).
- HotelsCombined in 2018 (total cost $134 M).
- FareHarbor in 2018 (total cost $139 M).
- Getaroom in 2021 (total cost $1,300 M).
The company has 3 reportable operating segments, and their most recent annualized revenues are:
Author's compilation using data from Booking Holdings' 10-K filing.
It is noted that the company does not provide a breakdown of each segment's profitability.
In the Bookings' model:
- Agency revenues consist almost entirely of travel reservation commissions paid by the service provider (there is no transaction between the consumer and the company.
- Merchant revenues are derived when the consumer transacts directly with the company generally for accommodation reservations and rental car reservations.
- Advertising and other revenues are derived primarily from revenues earned by Kayak and OpenTable.
Bookings has 6 regional brands:
... and the over-arching Booking.com brand.
The services offered by each brand are shown on the following chart:
The company claims that only 13% of its revenues are generated in the US and 79% from the Netherlands. It is noted that this is unlikely to be strictly true - it is a function of how the transaction processes operate within the company. I suspect that the company's US transactions are much higher, but they are processed outside of the US.
Business Overview
The company operates 6 primary online brands:
- Booking.com - the largest online accommodation booking site in the world.
- Priceline - a US-focused hotel, rental car, airline ticket, and vacation package reservation site.
- KAYAK - a meta search site, which allows consumers to search and compare travel itineraries and prices, including airline tickets, accommodation, and rental car reservation information from hundreds of websites.
- Agoda.com - an Asia-Pacific focused accommodation site.
- Rentalcars.com - a worldwide car reservation site.
- OpenTable - a provider of restaurant reservation and information services to consumers and restaurants.
Bookings' revenues come from 5 sources:
- Commissions earned from facilitating reservations of accommodation, rental cars, and other travel services on an agency basis.
- Merchant transaction revenues and customer processing fees from the selling of accommodation, rental cars, airline tickets, attractions, and in-stay services, and vacation package reservation services.
- Selling advertising, primarily on the KAYAK website and mobile apps, as well as from referrals to online travel companies and travel service providers.
- Reservation revenues are paid by diners seated through OpenTable's online reservation system and subscription fees for restaurant management services provided by OpenTable.
- Commissions from selling ancillary services including travel insurance and global distribution system reservations.
Booking Holdings was a first mover in the Online Travel (OTA) market and consequently, its brands enjoy strong consumer support. One of the company's key differentiators early on was in its choice of market strategy.
The traditional approach in the OTA market was via a merchant model. In this approach, the OTA secures "inventory" from its suppliers (hotel chains, airlines, etc.) and sells them to consumers. The customer pre-pays (often months in advance) for the service. This approach is fantastic for OTA cash flow, but not so great for consumers.
Similarly, the merchant model provides lower margins for suppliers and often leads to tension between the merchant and the supplier over pricing (particularly if the supplier is also selling directly to the consumer).
Booking Holdings adopted a new approach to the sector called the agency model. This model grew out of the fact that the company was a young start-up that found it hard to attract inventory. In this approach, the company partnered with its suppliers to sell their inventory. This approach became popular with consumers because they only pay when the service is delivered, and it is also popular with suppliers because it is a higher margin option for them.
As a result of their unique approach to suppliers and consumers, Booking Holdings was able to grow its partner base very rapidly (it became particularly popular with smaller suppliers and therefore its product offering was relatively different to its competitors) and revenues grew faster than the sector average.
In 2018, Bookings updated its strategy to:
- Implement a "connected" trip approach (where Bookings provides a whole trip product offering including air travel, accommodation, car hire, local attractions, restaurants, etc.).
- Increase its alternative accommodation inventory (smaller boutique properties including competitive offerings to Airbnb (ABNB)).
- Implemented a payments platform.
This strategic shift saw a significant shift in the revenue mix towards the merchant model. This can be seen in the following chart which shows the revenue split by model:
Author's compilation using data from Booking Holdings' 10-K filing.
Although the company does not show the margin breakdown by sales model, the company has stated that the merchant approach has lower margins than the agency model.
Bookings Holding provides data on the number of room nights, airline tickets, and car rentals that it sells. The following chart shows the movement in this mix:
Author's compilation using data from Booking Holdings' Quarterly Earnings releases.
The company does not provide any information about its revenues or margins at a product level (nor do its competitors).
Online global travel market
According to Statista , at the end of 2022, the online travel market size worldwide had gross revenues of $475 B and the market is expected to grow at 9.9% per year through to 2030.
If we look only at the listed online travel agent (OTA) market participants, the 10 largest listed companies in terms of 2022 reported revenues (this is reported revenues, not TTV) are shown in the following table:
Author's compilation using data from Guru Focus.
I have used the GuruFocus database to compile a time series of aggregate revenues of these companies since 2006:
Author's compilation using data from Guru Focus.
The chart shows the severe impact that the COVID pandemic had on the revenues of the OTA sector. By the end of 2022, the sector's revenues had recovered back to the pre-COVID levels.
Travel is largely a discretionary consumer spend - this chart shows that prior to the pandemic the global economy was slowing, and the sector's growth rate was between 6% to 7%.
The key takeaways from the table and the chart are:
- The OTA sector is dominated by 3 companies who generate almost 85% of the sector's revenues.
- The sector's total revenues have now recovered back to pre-COVID levels and a growth rate of 6% to 9% over the next few years is potentially achievable provided the world's economy does not enter a recession.
Booking Holdings' Historical Financial Performance
An earlier chart showed the changing nature of Bookings' revenue mix. The company had been growing revenues at greater than 15% per year between 2006 and 2018, but prior to the COVID pandemic, the rate of growth had dropped dramatically.
Author's compilation using data from Booking Holdings' 10-K filings.
Note that I have made some adjustments to Bookings' reported financial statements. I have eliminated the impact of any one-off costs and I have also reclassified some expenses (such as my estimate for their brand advertising and product development) as investments. The impact of these changes is to increase the operating margin and increase the level of invested capital.
Readers should note that although revenues have now exceeded the pre-COVID levels, operating margins have not. At this stage, it is unclear as to whether margins will remain at these lower levels into the future.
Although margins are currently lower than historical levels, compared to Expedia and Airbnb, Bookings' margins are significantly higher.
The strength of a company's competitive position is generally reflected in its return on invested capital. As stated previously, I have made some adjustments to Booking Holding's financial statements to more appropriately reflect where the company is investing its cash. I have taken these amounts and created a synthetic technology asset and a synthetic brand asset. I have added back into the modified Income Statement a notional amortization charge for these investments based on a 3-year asset life.
The history of my adjusted return on invested capital ('ROIC') for Booking Holdings is shown in the following chart:
Author's compilation based on author's financial model.
COVID obviously negatively impacted the company's earnings in 2020 and consequently, the ROIC was lower. The chart indicates that post-COVID the ROIC is rapidly returning back to its historical levels.
Booking's ROIC indicates that it must have several competitive advantages. I suspect that these include its brand, the network effects that users (both customers and suppliers) derive from being part of Bookings' product suite, and finally, the cost advantage that Bookings derives from its scale.
Although Bookings appears to have quite a wide moat, I am not convinced that it is very deep. I think the Bookings business could easily be replicated by a company with financial strength (such as Google (GOOG)(GOOGL) or Facebook (META)).
A review of Bookings' cash flows later in this report may provide further insights as to why the ROIC is so high.
Booking Holdings' Capital Structure
The following chart shows how Bookings' capital structure has changed over time:
Author's compilation using data from Booking Holdings' 10-K filings.
The chart shows that Bookings has been slowly increasing its debt levels whilst keeping its debt ratio (until recently) relatively flat. Bookings' debt ratio is reasonably modest compared to a typical industrial company but compared to most technology companies it is now becoming relatively high (for example Google's ratio is around 3% and other large IT companies would be typically around 6%).
I remain comfortable with Bookings' debt ratio if it doesn't go above 20%. The volatility in Bookings' cash flows that might be caused by changes in the health of the global economy would not comfortably support higher debt levels.
Booking Holdings' Cash Flows
A review of Bookings' cash flows for the last 10 years reveals the following information:
Author's compilation using data from Booking Holdings' 10-K filings.
Notwithstanding the catastrophic impact that the COVID shutdowns had on the Bookings' business, we can draw the following conclusions from the table:
- 67% of the net operating cash flow is reinvested back into the business.
- 100% of the free cash flow to capital has been returned to shareholders.
- Debt has been used to replace about a third of the equity purchased from the market.
- Management has been able to significantly "shrink" the invested capital in the business and this has driven the company's high ROIC.
I suspect that Bookings will not be able to sustain the current ratio of stock buybacks into the future because of its growing debt ratio.
Due to the very capital "light" nature of the business, Bookings will continue to generate cash, which is superfluous to its requirements, but the buybacks will become a smaller proportion of free cash flow in my view.
Key Risks Facing Booking Holdings
There are several risks confronting the company which are significant and needs to be considered by any investor in the company:
- Google represents a potential threat to the Bookings' business model. Bookings is a large Google customer. It is noted that Google offers its own products called Google Flights and Google Hotels which compete with Bookings' products.
- It goes without saying that the global travel business relies on the buoyancy of the global economy and on the world being open for business. Bookings acts as the sales arm for many of the service companies (airlines, hotels, rental companies, etc.) it represents. The relationship that it has with these companies is very important, but it also contains a natural tension regarding margins. This balance needs to be maintained at appropriate levels to retain the goodwill of the service providers.
- Technology is a key component of the company's business. The company must maintain high-quality applications which are easy to use, reliable, and secure. There is a significant risk that the company's IT infrastructure may fall behind in capability or become corrupted.
- Governments increasingly see large multinational software companies as soft targets for anti-competitive and privacy breaches. Laws are constantly changing, the compliance obligations are becoming more onerous and the financial penalties more expensive.
- Meta-search OTA's continue to place pressure on the OTA sector margins. The larger OTA's have a meta-search brand in their stable of products as a defensive measure to maintain market share.
- The company's Agency model has been the historic source of its high margins relative to its competitors. Growth is coming through the expansion of Merchant sales which tend to have lower margins.
My Investment Thesis for Booking Holdings
The global travel agent market is highly fragmented and mature. The OTA segment was established around the time of the "dot.com" era (early 2000's). OTA has been taking share from the traditional High Street agencies ever since and this has enabled the segment to achieve extraordinary growth rates during its establishment phase.
OTA's growth rate had started to taper prior to the COVID pandemic simply due to the law of large numbers and the entire travel market was devastated during the pandemic as the world was shut down. The last 18 months have once again been very strong for the OTA segment as the world reopened and industry volumes have returned to pre-COVID levels.
With volumes back to "normal" levels I expect that the sector's growth rates will return to pre-COVID levels provided that the global economy remains reasonably strong.
Bookings has started 2023 relatively strongly compared to its main competitors (Expedia and Airbnb). Q1 year on year revenue growth was 40% despite concerns that the global economy is expected to slow at the back end of the year.
I estimate that Bookings has been gaining market share against its listed competitors over the last few quarters and I expect that this trend will continue. This will enable Bookings to grow revenues at a faster rate than its OTA segment competitors.
There is strong evidence to suggest that the world may enter a more difficult economic environment for the remainder of 2023. This is certainly not factored into the consensus revenues for Bookings in the current year, but analysts have certainly throttled back growth estimates for 2024.
I have not attempted to forecast the impact of any potential recession on Bookings' near-term performance, but I have moderated my longer-term growth rate to account for any near-term headwinds.
I expect that over the long term, the travel market will continue to grow at its mature rate of around 4%. The OTA segment will have higher growth than the underlying market as the participants continue to take share from the traditional "bricks and mortar" travel companies. I expect that this will be around 6% for the next 5 years.
Bookings has sustained higher growth rates than its competitors for a long period of time and I expect that this will continue.
Bookings has benefited from excellent management over many years who have made sound decisions regarding the company's strategy and capital allocation.
This has resulted in segment-leading margins and returns on invested capital. Operating margins have yet to recover back to pre-COVID levels despite a recovery in revenues. I suspect that this is a function of a changing operating environment and product mix. I don't expect margins will return to their historical levels. It is also inevitable that margins will slowly decline over time as the segment matures and the cost of growth increases, I still expect that Bookings' margins will remain quite high relative to their competitors.
More competitors with deep financial strength may very well enter the OTA market over time but there is plenty of room for them in this highly fragmented market. This will also be another contributor to lower long-term margins.
Due to regulatory concerns around market share, I am not forecasting any significant acquisitions of major competitors during the forecast period, but Bookings will need to continue to reinvest (in both technology and branding) to sustain its market leadership. I have assumed that the historical rate of reinvestment is maintained into the future.
Key Inputs in Booking Holdings' Valuation
The following table reflects my inputs into the valuation:
Author's valuation model inputs.
A couple of technical issues to be noted with the valuation inputs:
- I have assumed that the Netherlands' lower tax arrangement will end within the next 10 years.
- I have assumed that all the outstanding restricted stock units and performance rights are converted into ordinary shares.
- I have treated the deferred revenue balance as a liability and therefore deducted it from the company's valuation.
- I have assumed that the company's risk profile is lower than the typical US company and therefore assigned a terminal cost of capital below my current estimate of the US median cost of capital (9.3%).
Discounted Cash Flow Methodology
A Free Cash Flow to the Firm approach is used with a 3-stage model (high growth, declining growth and maturity). The model only seeks to value the cash flows of the operating assets. The valuation has been performed in .
The output from my DCF model is:
I also developed a Monte Carlo simulation for the valuation based on the range of inputs for the valuation. The output of the simulation was developed after 100,000 iterations.
The Monte Carlo simulation indicates that 70% of the variation within my valuation estimate comes from the uncertainty associated with future revenue growth. The future growth rate is the key to the valuation.
The simulation indicates that at a discount rate of 9%, Booking Holdings has an intrinsic value of between $1,430 and $2,351 per share with an expected value of $1,825.
Final Recommendation
Bookings has been a good long-term investment for its shareholders. I estimate that the 10-year return has been about 13.3% per year however there have been many occasions where the stock has been both cheap and expensive. With some skillful trading, the returns potentially could be much higher.
There is considerable uncertainty about the expected economic environment for the remainder of this year. I think that the market currently has priced in relatively higher growth rates for Bookings and has not considered any recessionary impacts.
The following table is my model's valuation for Bookings based on a range of 5-year revenue growth rates:
Author's model.
The table is indicating that the market is currently pricing a 17% revenue growth rate for the next 5 years. I think that this is certainly possible, and Bookings had been achieving that level of growth before COVID but I think that it is an unlikely scenario simply due to the projected lower growth of the underlying travel market.
The current price almost assumes that Bookings will gain all the expected market growth at the expense of its competitors.
Do I think that Booking Holdings is a good long-term investment?
Bookings is a good company. It has sector-leading margins, revenue growth, and return on invested capital. It is also well-managed. By any definition, Bookings would be a good investment at the right price.
What should existing holders of Bookings' stock do right now?
The travel sector is cyclical. The best time to own stocks in this sector is when the economy (and discretionary spending) is strong. The global economy by many metrics appears to have reached its post-COVID peak and is now slowing down. This is the time to carefully evaluate all cyclical stocks within your portfolio.
Let me acknowledge that I am a shareholder of Bookings and I have held shares for several years. I have been taking advantage of the recent share price rally (which is at an all-time high) and based on my valuation and the near-term economic prospects, I have been selling down my holding. My current allocation is now at my portfolio minimum for this stock.
I recommend that it is time to take profits and wait for a better price.
For further details see:
Booking Holdings: Cyclically Time To Lighten Up