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Expedia Shares Hit by Marketing Cost, Demand Slowdown

Despite a travel industry demand slowdown--highlighted by hotel operators this earnings season--Expedia EXPE reported solid 9% third-quarter bookings growth versus our 8.5% estimate, representing a 20% two-year stacked lift versus a 22%-25% range over the previous four quarters. That said, profitability visibility is now lower, as Google is making it harder for industry operators to get free organic search traffic, leading to a shift to more expansion in performance marketing channels. As a result, Expedia lowered its 2019 EBITDA target to 5%-8% growth from 12%-15% prior.

We now see structurally higher customer acquisition costs, and plan to lift our 2019-23 average marketing spend as a percent of sales to around 54% from 52%, but still believe Expedia's network advantage (source of its narrow moat) will allow it to leverage the expense line around 2022. In our view, the network advantage continues to be evidenced by Expedia's increasing mix of direct traffic, which can help offset higher costs that might occur in indirect marketing channels. It is also supported by its U.S. and international take-rates, which continued to remain stable at 11.8% and 15.6%, respectively.

Due to higher structural costs and lowering our 2019-20 bookings estimate from 9% average growth toward 7%, to account for softer industry demand, we plan to reduce our $185 per share valuation around 10%. Despite the shares falling around 10% after hours, we still see them as attractive, although we recognize that patience may be required. We see a negative read through for narrow-moat companies Booking Holdings and TripAdvisor.

Expedia is gaining share in the U.S. (around 60% of bookings), as its two-year bookings growth of 23% was well ahead of our 18% estimate and a pickup from the 17%-21% range posted over the last four quarters. That said, overseas markets posted two-year bookings growth of 16%, below our 25% forecast, as Expedia is seeing signs of lower hotel industry room rates.

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