Priceline's Big Run May Just Be Starting

The online-travel company, popular for its "name your own price" feature, reports quarterly earnings today after the stock market closes. Analysts expect earnings per share of $2.40 and revenue of $780 million. Priceline has benefited from growth in its international subsidiaries, namely Booking.com and Agoda.com.

In a challenging 2009 for the travel industry, Priceline was laudably able to increase revenue by 25%, followed by an acceleration to 32% last year. Investors underestimated the potential for Priceline's international unit, which grew 70%. Booking.com, which accounts for the bulk of the international business, has now contracted with more than 120,000 hotels, up 55% since last year.

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Many investors aren't aware that the domestic division (Priceline.com U.S.) accounted for only 30% of gross bookings in 2010, down from 39% in 2009. International gross bookings jumped 67% in 2010, compared with 14% for domestic bookings.

According to Bank of America's Merrill Lynch research, most of the future growth for Priceline will likely come from Europe. Historically, Internet adoption rates and the use of e-commerce sites for international consumers have trailed those of the U.S. In 2010, online hotel bookings in Europe represented only 27% of the $107 billion hotel market (PhoCusWright/Merrill Lynch estimates), about half that of the U.S.

There is no doubt Priceline's model for the future is now focused on growth overseas, as Priceline has been investing internationally. The company acquired Booking.com in 2004, Agoda.com in 2007 and Travel Jigsaw (an online car-rental service) last year. Booking.com has been a remarkable success, and Priceline hopes to achieve the same level of growth with Agoda.com, which focuses on Asia.

Despite the success in international markets, Priceline faces many risks. When it was first launched on Priceline.com, "name your own price" was unique and mysterious to travelers. Also known as "opaque," the price model is part of the merchant segment for Priceline, a higher-margin business, as opposed to the agency segment, in which Priceline acts as an agent in a transaction. With merchant sales, hotels offer a net rate to Priceline, which can be marked up to whatever Priceline desires. Merchant sales, which include "name your own price," and merchant-price-disclosed rates grew only 17% in 2010. Agency sales (mostly from Booking.com) grew nearly 60%. Competitors such as Travelocity and Expedia (EXPE) have also recently introduced their own opaque hotel offerings, and have likely had an impact in slowing growth in Priceline's merchant-sales segment.

Overall, the online-travel business is extremely competitive, with very low barriers to entry, as competitors such as Expedia, Travelocity and Orbitz all fight to win business. Flash-travel Web sites such as Jetsetter and Vacationist have also become quite popular, introducing a new method of buying travel online. And with the recent introduction of Facebook deals, and the popularity of group buying sites such as Groupon, travel portals such as Priceline might not be as relevant as in the past. Many travel providers, in an effort to eliminate the middle man, are also using Facebook Business Pages to implement a direct-booking system to reserve hotel rooms.

And in what might be considered one of the biggest competitive threats to Priceline, search giant Google (GOOG) recently completed the acquisition of ITA Software. ITA provides the technology that powers airline-search functionality for sites such as Kayak.com, Bing.com and TripAdvisor.com. While Priceline generates only about 5% of profits from airline travel , the move by Google could be extremely disruptive to the travel industry. Google is also building out its search technology to include hotel-price ads with booking functionality within organic search results. That could lead to higher customer-acquisition costs for Priceline, namely more advertising dollars spent on Google to capture business. In fact, online-advertising expenses for Priceline's U.S. business grew at a faster rate than gross profit for 2010.

Despite the competitive pressures, TheStreet Ratings' quantitative model has a "buy" rating and a $714 target on Priceline, offering nearly 32% upside from current levels. The company scores best for efficiency, which measures a company's strength and historic growth of return on capital. Priceline produced a 23% return on invested capital (ROIC) in its most recent quarter, which scores greater than 90% of the companies we review. With a current ratio exceeding 4, and a debt-to-equity ratio of 26%, Priceline also scores highly for overall solvency, which measures the ability to meet current and future debt requirements.

Our model doesn't like the overall volatility for the stock, given the three-year beta of 6.15, and the valuation, with the stock currently trading at 53 times trailing 12-month earnings. However, on a forward-looking basis, the stock is more reasonable, trading at just 28 times 2011 and 22 times 2012 estimates. If expected annualized growth of 22% can be achieved over the next several years, the stock appears attractive, trading at a PEG of only 1 on 2012 estimates.

Among Priceline's direct competitors, CTrip (CTRP) is the only other stock rated a "buy" by TheStreet Ratings' model. Orbitz is rated "sell," with Expedia and Travelzoo (TZOO) rated "hold." CTrip is a China-based travel provider and a direct competitor to Priceline's Asian subsidiary, Agoda.com.

Priceline is now an international growth story, offering the best so-called pure play on increased penetration for online travel in international markets. The stock is not without risk, as the competition is fierce, with recent strategic moves by Google only adding to the fire. For investors with a high appetite for risk looking to capitalize on growth in the European, Asian and South American travel markets, Priceline appears to be an attractive investment.