Book A Trip To Undervaluation With Expedia Group Stock (NASDAQ:EXPE)

Expedia Group (NASDAQ:EXPE) has had an interesting journey over the past decade. Starting out with impressive growth, it soon found itself in crisis when the COVID pandemic hit. Peter Kern took the helm as CEO in 2020 and worked to keep the company alive and reshape it for a brighter future. As Kern’s contract is complete, Q4 earnings served as a passing of the torch, while he summarized his accomplishments.

With Expedia entering this new phase of its life, the market was not optimistic, and share prices dipped shortly after the release. It’s therefore worth examining what prospect there is in this improved business and new share price. Ultimately, I concluded that Expedia is not only an excellent business but undervalued, making it a textbook buy.

Financial History

Let’s do a quick review of how this company fared and transformed over the past decade.

Expedia was on a track of stellar growth. The travel industry was among the hardest hit by the COVID pandemic, and 2020 results show this. This was, in fact, the only year that free cash flow turned negative that year, and During Q4 earnings, Kern (who took the job of CEO that April) reflected:

As many of you know, when I started this unexpected journey during COVID, travel was at a standstill. Money was flowing out of the company faster than we could replace it. And our people, our shareholders, and most of the world were unsure how and when we would ever come back.

The company had to raise almost $4 billion in long-term debt to stem the bleeding. Yet, by 2021, cash flows were positive as the company grew its bookings again and with steady revenue margins.

Long-term debt was decreased from $8.2B in 2023 to $6.3B by 2023, with the company also sitting on $4.2B of cash, once again enjoying a financially healthy state.

Newer Business Model

Kern moved to revamp the business model, shifting Expedia more toward that of a leaner, online platform. In addition to that, the strategy has focused prioritized recurring, longitudinal customers through internal marketing efforts (such as loyalty programs in their app). The prior strategy had been aggressive (and expensive) customer acquisition, with little concern for their ROI to Expedia over time.

Their three main brands are Expedia, Hotels.com, and Vrbo. Let’s examine their segments and the way their revenues sources are split, coming out of 2023.

Revenue comes from three segments: B2C, B2B, and trivago (which does advertising instead of bookings). B2C is by far the largest, at 71% of revenues, but B2B has been growing more.

Similarly, lodging produces 80% of revenues across the brands and segments.

Merchant services lead this category. These are earned directly from customers when they make payment for a booking. The agency service, by comparison, earns a fee for the company that receives the booking (finding them customers).

Their loyalty program, known as One Key, works across all of these brands and segments, allowing customers to earn and redeem flexibly. One Key is a major part of their new strategy, as it will help them retain likely customers as long-term revenue sources.

A Look to the Future

Let’s take a look at the challenges and upsides Expedia will face going forward, which affect growth

Long-Term Debt

Their long-term debt, which largely enjoys low rates, has its maturities fairly staggered over the next seven years.

While some of this could and may yet be refinanced, I believe that cash on hand, on top of recent operating cash flows, should be sufficient to repay all of this. Moreover, the interest earned on their cash position essentially covers the overall the interest expense. Expedia used its capital well, despite the challenges posed by 2020, and I believe the balance sheet will show increasing strength over time.

Buybacks

While the company suspended their dividend in 2020 with the onset of COVID, buybacks never totally ceased. The history of buybacks has been hard to summarize over the past decade, but 2023 indicated a change in the winds.

This history is their “net buybacks,” which I calculated based on total share repurchases and including the effect of stock-based compensation and new issues from employee purchase plans. 2023 saw a huge increase from this figure, mainly by the record $2.1B spent repurchasing shares that year.

I believe that dividends will not reemerge as part of the long-term return here, and I think buybacks will be the main way value is returned to shareholders.

Streamlining of Sales by AI

I want to highlight another remark by Kern during Q4 earnings:

…you said what am I most excited about? It’s really machine learning and AI plumbed into essentially the entire product experience, because what that gets you is effectively a personalized experience for every customer and that’s from the front end basic shopping flows as I mentioned to post-booking to CRM and everything else and the more we can connect and now that we have a single identity for our customers, and now that we can use that data to give them the best experience we’re seeing some of our best wins now just as algorithms improve and learn and new versions come out whether it’s to optimize pictures or content or what you see in what order what filters are applied like those kinds of things that we can now do at scale

In many of my recent theses, I’ve been hard on stocks driven up by the hype of AI. Yet, I think Expedia is exactly the kind of company that will benefit from it and whose valuation does not reflect it for some reason. The shift to its tech platform in the lead-up to this generative AI boom is almost perfect. This alone can create a lot more business and with more efficiency going forward.

Competition vs. Growth of Market

While I believe Expedia’s brands are strong, there are many other worthy brands that provide similar services: Kayak.com, TripAdvisor, Priceline, and even their own customers who may attempt to bypass players such as Expedia and reach customers directly. Many of them will also enjoy benefits from the advent of generative AI in their sales. This could interfere with some of Expedia’s business. Yet, I believe there are long-term tailwinds for them too.

After the adjustments of COVID, we see that the global tourism industry reached a new high of business done in 2023, as if the trend had never ceased. Thus, while the market is competitive, it’s also a blue ocean. Kern himself noted in Q4 earnings:

Our fourth priority will be to continue cementing our leadership in the B2B segment. Revenue in this segment grew a stellar 33% in 2023 versus 2022. While it benefited from the APAC reopening, and we expect those geo tailwinds to moderate somewhat this year, we are still expecting very strong growth given our differentiated capabilities and a huge TAM to still penetrate.

Overall, I believe that there’s too much business to be done for competition to be the main concern. When I worked at Fidelity and helped folks plan their 401Ks, the main thing these future retirees said they wanted to do in retirement was travel, almost without exception. There is a long-term tailwind here. Expedia has reformed to be swift and efficient in its internal operation, and that is all that is needed to succeed in this environment.

Headwinds and Risks

The transformation is not entirely complete. The company recently disclosed that it will incur between $80M and $100M in severance for the elimination of about 1,500 jobs. For the next year, this means operating costs will be a bit higher, but that will be lower costs for a leaner business thereafter.

This phase aligns with the transfer of CEO from Kern to Ariane Gorin, which takes effect in May. Gorin has led the B2B business, and so she is a natural successor given Expedia’s focus on growing that segment ambitiously, but it’s the next year or two will be a test and adjustment that may not immediately boost the cash flows.

Lastly, folks always need to remember that travel and tourism is always mixed with various international risks, be they political or meteorological in nature. A war at the wrong time (like Ukraine-Russia) or another disaster like COVID can hurt such a company. Similarly, during a recession, people are more likely to give up on travel, which is considered a luxury.

A setback doesn’t have to wipe them out either. It just needs to weaken cash flows such that the valuation lowers and, with it, the price of your shares.

For example, Expedia’s lowest point in the past decade was the COVID crash, lower than even when it was a much smaller business. If you needed to cash out then, you were taking a disappointing loss.

Valuation

We now come to our valuation. I will use a Discounted Cash Flow model for a single share, in order to reflect the effects of buybacks over time. I’ll make the following assumptions.

• $2 billion in baseline FCF, which works out to $14.60 per share
• 10% growth in FCF the first 5 years
• 5% growth the second 5
• Additional 2% growth across the decade from buybacks
• Terminal Multiple of 10

The FCF estimate is based on the low end of post-2020 FCF. Expedia, meanwhile, enjoyed double-digit growth in business over the past year, and while they expect growth in B2C to slow down, there is more potential offered by their B2B line and with the opportunity in AI-enhanced sales. Given that, I think 10% growth in FCF is reasonably likely for the first half of the decade, with room for it to slow down in the latter half.

Similarly, the company need only contribute about half a billion each year (based on recent prices) to grow FCF per share by at least 2% each year. Given its improved balanced sheet and likely room for ongoing growth over time, I also expect this company is unlikely to be lower than a multiple of 10 in the future.

That gives us an intrinsic value of about $290 per share, suggesting a pretty sizable discount to its fair value and perhaps a great return from any buybacks the company is now making.

Even if we only count the 2% from buybacks and assume no operational increase in FCF, that still gets us $167 per share. The company is undervalued even for lackluster results but has the right pieces in place to leave us pleasantly surprised.

Conclusion

Expedia made the right changes in the aftermath of COVID to become a leaner, higher-ROI machine in 2023. While it won’t enjoy explosive operational growth like some of the AI hype stocks, it will still benefit significantly with its more tech-driven model, and for whatever reason, the company is not priced at a premium to that growth like so many other stocks are right now.

This mismatch is an opportunity for the long-term investor: a wonderful business at a fair price. That’s why I rate EXPE a Buy for the foreseeable future.