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We have long viewed this hotel cycle as lasting through 2017 (eight years versus typical cycles averaging seven to nine years), and during 2015, we cautioned that investors were pricing in optimistic assumptions for lodging stocks, which we viewed as overvalued at the time. We feel vindicated by recent commentary from hotel consultants pointing to industry supply matching demand in 2017 (which we believe will lead to the end of this cycle as we approach 2018, in line with our forecasting), as well as the recent correction in lodging stock prices, which had been pricing in unrealistic assumptions, in our opinion.

We reiterate that 2016 travel demand looks solid, as witnessed by the most recent airline quarterly reports, commentary from Marriott's CEO, and still-healthy revenue per available room expected by hotel consultants. As a result, we are making no changes to our average 2016 RevPAR forecast of around 4.5% for our hotel coverage. That said, commentary on increasing hotel supply growth along with heightened economic growth concerns make us even more cautious on our forecast industry RevPAR slowdown in 2017-19. We currently forecast RevPAR growth in 2017 to average around 3.5% followed by 0%-2% growth in 2018 and 2019. We plan on reducing RevPAR in each of these years by roughly 2 percentage points, resulting in a planned 2%-5% cut to our lodging fair value estimates. Although we see lodging stocks as undervalued, the recovery to our fair value estimates could be prolonged by investor sentiment around decelerating industry growth. For those looking for travel exposure, we recommend top investment idea

Three hotel consultants reduced their 2016 U.S. industry RevPAR forecasts to an average of 5.3% from 5.9% (we maintain our average 4.5% 2016 RevPAR estimate for our lodging coverage), driven by decelerating year-over-year demand growth (2016 demand forecast up 2.1% versus 2015 demand growth of 3.2%) and accelerating year-over-year supply growth (2016 supply growth forecast up 1.7% versus 1.1% supply growth in 2015). Demand should still exceed supply in 2016 and allow for slight gains in hotel occupancy with stronger gains in rates, but supply growth could match demand growth in 2017, creating an end to this cycle. At this time we don't expect a major contraction in 2018 and 2019 RevPAR, as the U.S. active pipeline is still 28% of the prior 2008 peak, and at 457,000 rooms represents high-single-digit incremental room growth over the next few years.

While we are not changing our fair value estimates for Priceline or Expedia EXPE at this time (they report quarterly results in a few weeks), we note that slower-than-expected RevPAR growth in 2017-19 could have slightly negative implications for these companies. On one hand, we expect continued secular online penetration growth to mitigate cyclical slowdowns in hotel and travel. Additionally, Priceline's Name Your Own Price opaque business should see increased demand in environments where hotel operators have a marginally more challenging time filling rooms; we've made no changes to our Priceline 2017-19 revenue forecast, which remains below Street consensus). On the other hand, stronger demand in the Name Your Own Price business creates cost of goods sold expense for Priceline. Furthermore, while online travel agency models like Priceline could see increasing demand from travel operators in a tighter market, Priceline could also respond with higher advertising and IT expenses in order to drive demand and conversion. Should higher expenses in 2017-19 become a likely scenario, it would probably only result in a low-single-digit adjustment to our $1,830 fair value estimate.

We see airline passenger growth as offering signals that travel remains solid, but the mention of booking pressure after the Paris attacks signals that some near-term booking weakness may have occurred, which may be corroborated by the recent slowing in U.S and European RevPAR. While we think any weakness specifically resulting from the Paris attacks is transitory, we estimate Priceline gets around 55% of its total bookings from Europe versus an estimated 35% for Expedia. Also, France is the third-largest travel booking market in Europe, with 18% of total bookings in 2013, according to Phocuswright. If one were to assume that 20% of booked/planned trips to France were canceled/delayed, that could result in around a 2-percentage-point booking headwind for Priceline in the fourth quarter and into the first half of 2016. As a result, we plan to reduce our fourth-quarter international constant currency booking estimate to 22% from 24%, while reducing our 2016 forecast to 23% from 25%. Airline yield pressure is likely to continue to hurt Priceline's U.S. bookings and Expedia's overall bookings. Importantly, lower airline fares have no impact to gross profits for either company, as commissions are received on a per-ticket basis. Lower airfare prices drove weak U.S. booking guidance given by Priceline last quarter, but overall gross profit growth was forecast to continue to grow above total booking growth, which is what investors need to focus on. We plan to slightly reduce our near-term U.S. booking forecast, but this will have no impact on gross profit or our fair value estimate for Priceline.

Network Leadership Hard to Replicate We expect Priceline's global online travel agency leadership position to expand over the next decade, driven by a superior position in China, continued leadership in Europe, and an expanding presence in vacation rentals and restaurant bookings. We see the firm's global share of global travel bookings reaching high single digits in 2020 from 5% in 2015.

Priceline has built a leading network of hotel properties and other services, which drives an increasing user base. We see this network effect expanding in both developed and emerging markets, as well as vertical markets such as vacation rentals. In developed markets, replicating Priceline's leading network in Europe is proving costly for key competitors, as boutique hotels (a substantial portion of the region's market) that are already signed with Priceline face labor and expense constraints in joining multiple distribution channels. In emerging markets, the firm is expanding its leadership in China with its Ctrip partnership and in Latin America with Hotel Urbano, which is crucial, as we see developing regions representing around 60% of total industry online booking growth over the next five years. The acquisitions of Kayak and OpenTable also extend the network globally.

This expanding network positions Priceline well for the increasing global shift to booking via mobile applications. Booking.com is a top-five travel application in 66 markets around the world, while Expedia ranks second among online travel agencies and is ranked in four markets as a top-five travel application.

Companies that pose the main risk already have the customer traffic and budgets to replicate the network Priceline has built. Focused entry from Google GOOG/GOOGL, Facebook FB, Amazon AMZN, and others could double the current handful of players that have dominant scale, leading to commodification of the industry and a meaningful impact to profitability. That said, replicating Priceline's network requires significant time and expense.

High Returns, but Potential Competition Prevents Wide Moat We see Priceline as having a narrow economic moat driven by its sustainable network effect in the online travel industry. Priceline established its moat with the Booking.com acquisition in 2005. Using its size, Priceline was able to increase spending to promote Booking.com to both hoteliers and travelers. For travelers, Booking.com was intriguing because it offered agency bookings, which allowed them to pay after a hotel visit versus having to pay up front with merchant bookings. This helped drive increased customer traffic (the demand side of the network effect equation), which in turn drove hotel inventory to the website (the supply side of the network effect equation). This created a positive virtuous cycle at a time when no other competitor had begun to build scale in Europe; customers joined and hoteliers joined, which drove further hotel inventory and customer traffic.

Priceline's size and market position should sustain its network effect. Priceline and Expedia each control more than 30% of the online travel agency market, and Orbitz had controlled around 8% before being acquired by Expedia. Beneath this combined 70% share it is highly fragmented, making it extremely challenging for any smaller new entrants to gain customer traffic or supplier scale. Smaller new entrants would need substantial human capital to build relationships with hotels and gather crucial hotel information and photos from those hotel properties. They would also need to spend heavily on advertising to attract customers to the website, and any customers they did get would require IT, data center, and 24/7 customer support services to retain. Priceline is able use its strong and sustainable cash flows to acquire and partner with attractive products and brands, which builds out the supply offering. Priceline also is able to advertise well in excess of competitors, which helps drive brand and customer traffic. In 2014, Priceline spent $2.6 billion on advertising, which was 30.7% of its total revenue. Expedia and Orbitz spent $2.25 billion and $334 million in 2014, which was 39.1% and 35.8%, respectively, of total revenue. As scale is built, understanding of consumer behavior also increases, which leads to improved customer experience and conversion.

Unique to Priceline is its strong position in international markets, hotel travel, and agency bookings (versus merchant). International markets are less penetrated than domestic markets and have more boutique than branded hotels. For example, in Europe independent hotels represent about 60% of the market versus only 30% in the United States. Because these boutique hotels are too small to effectively market, their dependency on the online travel agencies for marketing and distribution is greater and stickier. These boutiques are unlikely to use multiple online distribution channels, because their size does not allow staffing to actively manage inventory and relationships with multiple partners. This boutique dynamic also holds true in most emerging markets where Priceline has a strong presence through its Ctrip partnership. Hotel bookings are less penetrated online than air (30% versus 50%) and less brand oriented than air (online travel agencies have a stable 50% share of online hotel bookings versus a declining 30% share of online air bookings). Hotel exposure offers faster growth (low-double-digit hotel booking growth versus mid-single-digit airline booking growth) and higher negotiated commission fees (midteens for hotels versus midsingle digits for air) versus air. Finally, Priceline generates a higher level of its bookings from agency, which is preferred by travelers and doesn't require the processing costs that merchant does.

Priceline's position in these relatively attractive markets is higher than the other Tier 1 online travel agencies, which results in higher returns on invested capital and market share. We project adjusted ROICs to average 118% over the next five years for Priceline. Additionally, we forecast Priceline's market share of global travel bookings to reach high single digits in 2020 from 5% in 2015, versus Expedia's market share (including Orbitz) approaching high single digits in 2020 from nearly 6% in 2015.

Despite its very high ROICs, we don't believe Priceline has carved a wide moat, given potentially meaningful competition beyond the next 10 years from new entrants that already have the customer traffic and budgets to build network scale, including Google, Facebook, Amazon, and hotel consortiums. That said, we expect the market to support some level of increased competition over the next several years, and we currently see Priceline has having the strongest network. The travel booking market remains large at $1.2 trillion, and online penetration of the travel market remains low at around 40%.

Industry Susceptible to Economic Downturns Priceline derives most of its revenue from international markets. This exposes it to exchange rate fluctuations that are often near term yet can meaningfully affect sales and profitability.

Rate parity clauses prevent hoteliers from offering cheaper rates on their websites than are offered on the online travel agency websites. The full removal of rate parity would create an environment for competition. That said, we would view any margin impact as near term, as the ability of hotels to offer promotions to their loyalty members or competitive distribution platforms can also be matched by loyalty programs of the major online travel agencies, in our opinion, and we believe hotel operators will be careful with promotions in order to not drive lower pricing and potential brand destruction.

The growth of the online travel booking market remains attractive, and there is an ongoing threat that large companies with sizable user traffic could enter the industry. Focused entry from companies such as Google, Amazon, and Facebook would have a meaningful impact on Priceline's growth.

The travel industry is cyclical and affected by changes in economic growth. In a downturn, consumers have less income and cut back on discretionary expenses like leisure travel. Priceline is not immune here, as revenue growth did slow in 2009; however, it still grew 24%, as the low penetration of developed markets and limited competition for its Name Your Own Price hotel offering provided some offset. If an economic downturn were to occur now, developed markets and Name Your Own Price would not offer the same cushion as they did in 2009 because of more mature penetration and increased competition. However, the nascent penetration and Priceline's position in emerging and mobile markets would probably offer some cushion to a weaker economic growth environment. In the event of an economic downturn, we expect Priceline's growth to slow but to remain comfortably above Expedia's. Also, terror attacks can lead to a near-term disruption in bookings.

The primary risk we see to our Exemplary stewardship rating is from significant value-destroying acquisitions; for instance, although the purchase of OpenTable should offer moat-enhancing effects and is relatively small versus Priceline's total business, we view the purchase price as relatively expensive.