8 / 10 / 2006

Expedia Numbers 2Q06

Expedia’s numbers. There are a few things of note here. In my analysis actually Expedia’s gross bookings have fallen behind the US agency market which grew at 8% Y/Y. So in reality Expedia is not doing so hot in the US market. At least the brand’s growth has stalled if not going into decline.

Not factored in here is the loss of GDS commissions. That should put a dent of at least 10 % in their EBITDA with effect from the end of the year.

The new platform is even LATER than originally thought. Interesting to see how the spin has changed as the delay has lengthened.

The decline in Air volume was more than compensated by growth in other supplier sectors indicating a solid growth in the Packaging and White Label businesses. Air decline is however still a bad sign.

Less spend on marketing shows that their efforts to eradicate the wasted deals is paying off.

Read and digest. Comments anyone?

Cheers

Timothy

Timothy J O'Neil-Dunne
Managing Partner - T2Impact Ltd
Global Travel eBusiness
Tel (US) +1 425 836 4770
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From: Block, Marla A. (Manassas) [mailto:mablock@stifel.com] On Behalf Of Devitt, Scott W. (Manassas)
Sent: Thursday, August 10, 2006 12:17 PM
Subject: Expedia, Inc. (EXPE $14.98 Hold) Reports 2Q06 Results

All relevant disclosures and certifications appear at the end of this report.

Reports 2Q06 Results

• Gross travel bookings for the quarter were $4.6 billion, up 10% over the comparable year-ago period, and 7% domestically. Bookings through the Expedia brand grew 13% year/year to $3.6 billion and $621 million, or a 25% increase at Hotels.com.

• Expedia reported 2Q revenue of $598.5 million, an increase of 8% year/year, and OIBA of $184.2 million. Adjusted EPS for the quarter were $0.32 with diluted EPS of $0.27. We had estimated revenue of $572 million, OIBA of $128 million and adjusted EPS of $0.23.

• We forecast that Expedia will generate $582 million in OIBA in 2006 and $617 million in OIBA in 2007. For 2006, we estimate revenue of $2.3 billion and $1.05 in EPS. We forecast $17.4 billion in gross bookings for full year 2006, or growth of 12% year/year.

• At $15 per share, Expedia trades at 7.5x our new 2007 EBITDA estimate of $667 million. The company faces challenges including an entirely reconstructed management team over the past 2+ years and the highest margin structure in a competitive industry with limited sustainable economic advantages. All else being equal, we would be buyers of the shares around $14 per share as we believe those levels put the business at a valuation in which the possibility of a material buyback make the short-term fundamental challenges more palatable. We rate shares of Expedia Hold.

Our Thoughts

Expedia reported domestic bookings growth of 7% and international bookings growth of 22% compared to Priceline at 17.5%/117% and Travelocity 22%/19%. Expedia reported two metrics in the quarter that were material positives compared to recent history, an accelerating merchant hotel bookings growth rate of 17% and a revenue take rate of 13.1%. The revenue take rate declined by only 32 basis points YOY compared to more than 130 bps decline in 1Q06. However, management noted on the call that investors should expect 2H06 revenue take rate of roughly in line with the blended 1H06 rate. The company also reiterated its -5% to -15% OIBA growth figure for 2006.

In our opinion, in statistical terms, Expedia shares are quite reasonably valued at 7.5x 2007 EBITDA and 13x our 2007 cash EPS estimate. However, we do not believe the shares will appreciate meaningfully from current levels until the revenue take rate decline stabilizes and the company begins to stabilize its market shares, particularly in the U.S.

Results

Expedia reported 2Q revenue of $598.5 million, an increase of 8% year/year, and OIBA of $184.2 million. Adjusted EPS for the quarter were $0.32 with diluted EPS of $0.27. We had estimated revenue of $572 million and adjusted EPS of $0.23. Top line growth was primarily driven by increased worldwide merchant hotel revenue, partially offset by a decline in worldwide merchant air revenue. Domestic revenue increased 1%, and international revenue increased 35%, or 33% excluding FX impacts. Revenue as a percentage of gross bookings was 13.1% for the second quarter, down 32 basis points year/year. Management noted that they proactively cut the national TV ad spend for Expedia.com in the quarter, which impacted transactions, but allowed the company to drive some modest marketing leverage. Expedia saw continued significant year-over-year declines in traffic and transactions from MSN and affiliate channels at Expedia.com.

EBITA, or "OIBA" increased 6% year/year, driven by higher revenue and offset by higher operating expenses, particularly SG&A and marketing expenses. OIBA as a percentage of revenue was down 61 basis points to 30.8%, due to higher growth in G&A expenses as compared to revenue growth during the quarter. Operating income improved 41% during the quarter to $136 million. Gross profit for 2Q06 was $472 million, up about $40 million, or 10% from the year-ago quarter.

Worldwide merchant hotel revenue increased 17% for the second quarter, driven by 15% growth in room nights stayed, and a 2% increase in revenue per room night. Merchant hotel room nights were 10.6 million. Worldwide air revenues decreased 13% for the quarter, due to a 10% decrease in revenue per air ticket due to pressure on commission payments to agencies from airlines. Air tickets sold decreased 4%. Lower availability of merchant air inventory also impacted packages revenue, which grew 5% year/year to $131 million.

Agency gross bookings were 60% of total bookings for the second quarter and 59% for the prior year period. Agency mix increased during the quarter primarily due to a 13% increase in average airfares associated with airline bookings, which constitute the bulk of overall agency bookings, as well as a significant decline in merchant air gross bookings.

Gross travel bookings for the quarter were $4.565 billion, up 10% over the comparable year-ago period, and 7% domestically. International bookings of $1.109 billion represents a 22% increase year/year, or 21% excluding the effects of foreign exchange. We had expected gross bookings of $4.8 billion for the quarter. Bookings through the Expedia brand grew 13% year/year to $3.6 billion and $621 million, or a 25% increase at Hotels.com. Expedia® Corporate Travel grew gross bookings 47% in the quarter to over $250 million. 2Q bookings growth, which was down again sequentially was affected by lower merchant air gross bookings, particularly at Hotwire, and some impact from the World Cup in Europe amongst other factors. Domestic revenue margin was down 82 basis points to 12.8%, while international grew 134 basis points to 14.0%, benefiting from an increasing mix of merchant hotel bookings. The decline in worldwide revenue margin was primarily due to the decline in domestic air revenue per ticket, along with an increase in average worldwide airfares of 13%.

Expedia, Inc.'s international points of sale accounted for 24% of gross bookings and 26% of revenue in the second quarter, up from 22% of gross bookings and 21% of revenue in the prior year period. eLong, Inc. in which Expedia has a controlling interest, reached operating profitability during the second quarter.

Expedia, Inc. and Continental Airlines announced a five-year strategic partnership under which Continental's products and services will be marketed through Expedia.com and its affiliate sites. In addition, Expedia has begun flowing airline travel segments to Amadeus and Sabre, diversifying the GDS provider base.

For the six months ended June 30, 2006, net cash provided by operating activities was $723 million. Free cash flow for the quarter was $248 million. Management also announced the company had completed its earlier announced 20 million share buyback program thereby reducing the outstanding share base by over 5%, and recently announced an additional authorization for another 20 million shares. Expedia maintains a $1 billion five-year unsecured revolving credit facility, had $664 million in cash and equivalents and no debt on the balance sheet as of quarter-end.

Conclusion

Management commented that they were relatively conservative in the domestic Expedia.com marketing spend, which had the affect of higher marketing efficiencies and lower gross bookings growth in 2Q, but will have some affect on 3Q revenue.

Expedia, like other travel agents, continues to face a difficult operating environment in air travel, and management expects to see continued declines in revenue per air ticket.

Relating to the platform redesign, management commented that the company was on track with and will move its first point of sale on to the new platform early next year. Although travelers will not notice, it will enable greater efficiencies and improve search engine optimization. The company will transition other worldwide sites in 2007 and 2008.

Management remains confident that there's at least $50 million worth of annual OIBA improvements to be made and believe that the company will hit that run rate sometime in late 2007.

Management expects to see favorable comps in the back half of 2006 as the company anniversaries the striking of lower margin deals. Further, management continues to believe the company will see improved raw margin decline in 2006 versus 2005. G&A is expected to flatten in the back half of the year with favorable comps versus the second half 2005 than during the first half. Technology and content is expected to continue growing faster than revenue during the remainder of 2006 and see even higher year on year growth in 2007. Management anticipates full-year 2006 CapEx will come in between $70 and $85 million, which would represent annual growth of at least 35%.

At $15 per share, Expedia trades at 7.5x our new 2007 EBITDA estimate of $667 million. The company faces challenges including an entirely reconstructed management team over the past 2+ years and the highest margin structure in a competitive industry with limited sustainable economic advantages. All else being equal, we would be buyers of the shares around $14 per share as we believe those levels put the business at a valuation in which the possibility of a material buyback make the short-term fundamental challenges more palatable. We rate shares of Expedia Hold.