TripAdvisor Strengthens Its Network Effect

Despite intense competition, we expect

We expect TripAdvisor’s sales growth to slightly exceed the online travel industry’s high-single-digit annual rate we forecast on average over the next several years. Further, only around 25% of total travel advertising is spent online, versus 40% of total travel bookings done online. We believe this gap will close over time as advertising dollars become more aligned with industry bookings.

The company has built a leading network of user-generated reviews and content, which continue to drive an increasing user base. We see this network effect expanding, driven by both organic and inorganic actions but offset by increasing competition in the metasearch marketplace, where barriers to entry are lower than in the online travel agency booking space.

TripAdvisor launched its Instant Booking initiative, which strives to collect a piece of the booking transaction that previously had not been collected by the firm. This initiative expands the firm’s business model and revenue opportunity. Also, we are encouraged that the company has been allocating capital to acquisitions in the restaurant and tour markets, as we see strong growth opportunities for these markets in the online travel space. However, competition is increasing, driven by Kayak, Trivago, and Google GOOG/GOOGL, leading to elevated marketing costs over the next few years. In China, Qunar and CTrip CTRP are leading in terms of review, revenue, and advertising growth, which presents some challenges for TripAdvisor in this very important market. In addition, Google continues to expand its metasearch offering.

Nonetheless, TripAdvisor’s network advantage stands to remain and positions the firm well for the increasing global shift to booking via mobile applications. TripAdvisor is a top-five travel iOS mobile application in 12 markets, versus 1 and 45 for Kayak and Trivago, respectively.

Leading Position in Reviews and Content Drives Traffic We see TripAdvisor as having a narrow economic moat, driven by its sustainable network effect in the online travel industry. Over the past decade and a half, TripAdvisor has built a leading position in travel reviews and content (the supply side), which in turn has driven strong unique visitor traffic to its site (the demand side).

At the end of 2016, TripAdvisor had over 465 million reviews and 1,060,000 lodgings on its website. This leading supply of reviews and information has led to user traffic and revenue above those of key competitors Kayak and Trivago. For instance, Google Play reports app downloads as of year-end 2016 at 100 million-500 million for TripAdvisor versus 10 million-50 million for Kayak and Trivago. SimilarWeb data showed TripAdvisor had 131 million visitors in January, compared with 36 million and 20 million for Kayak and Trivago, respectively.

TripAdvisor’s leading position in the travel metasearch market results in strong returns on invested capital and market share. We project adjusted ROIC to average 78% during the next five years, well above the company’s 8.9% cost of capital.

Despite these high ROICs, we don’t believe TripAdvisor has carved a wide moat, given lower barriers to entry and potentially meaningful competition beyond the next 10 years from new entrants that already have the customer traffic and budgets to build network scale. We see online travel agents’ barriers as higher than user-generated review barriers such as TripAdvisor, which are in turn higher than metasearch platform barriers. Metasearch platforms don’t control the inventory they show on their websites; hoteliers and online travel agents provide this content. TripAdvisor can use its customer base to provide photos and other descriptive information on hotels. Still, obtaining the quantity and quality of hotel information and relationships that the online travel agents have would require time and substantial expense. The main barrier to new entrants replicating a metasearch platform is having the customer traffic to attract hoteliers and online travel agents to share their content. Companies such as Google, Amazon AMZN, Qunar (Baidu BIDU partner), Facebook FB, and Alibaba BABA have sizable user bases and budgets and can offer increasing competition.

We believe user-generated reviews provide a larger moat than metasearch platforms, but this barrier is not insurmountable. Again, one of the main barriers to replicating user-generated reviews is having a sizable user base. The barrier is higher relative to metasearch in that it takes time to gather reviews after the metasearch platform is constructed. Facebook, Google, Qunar, Priceline PCLN, Alibaba, and Amazon have the necessary user base to more quickly replicate this review moat. Focused entry from these competitors would double the handful of players with dominant scale, leading to commodification of the industry and a meaningful impact on margins.

That said, we expect the market to support some level of increased competition over the next several years, and we see TripAdvisor as maintaining a leading position. The travel advertising market remains large at $40 billion, and online advertising penetration of the total travel advertising market remains low at around 25%.

Barriers to Entry Not Insurmountable Growth of the online advertising travel market remains attractive, and there is an ongoing threat that large companies with sizable user traffic could enter the industry. Focused entry from companies like Google, Amazon, and Facebook would have a meaningful impact on TripAdvisor's growth, as the barriers to replicating the firm's business model are not insurmountable and could be duplicated within a few years, in our opinion. Additionally, Kayak and Trivago metasearch competition could intensify, driven by the deep marketing pockets of Priceline (which owns Kayak) and Expedia EXPE (which owns Trivago).

The travel industry is cyclical and affected by changes in economic growth. In a downturn, consumers have less income and therefore look to cut back on discretionary expenses like leisure travel. Additionally, companies generate less profit and cut back on advertising. If an economic downturn were to occur now, the nascent penetration of online travel advertising spending would probably offer some cushion, but we would still expect TripAdvisor’s growth to slow.

In addition, terrorism and other acts of war can lead to disruptions in travel. Pandemics can halt or delay travel purchases. Finally, customer concentration is a risk for the company, with Priceline and Expedia generating 46% of total 2016 revenue.

We view TripAdvisor’s financial health as extremely sound and its capital structure as conservative. While we expect high marketing and technology costs over the next few years as TripAdvisor ramps its Instant Booking initiative in a competitive landscape, we still expect the company to generate healthy free cash flow. Over the next several years, we believe free cash flow is likely to be used for buying back stock, small acquisitions, and investment in growth areas of the business.