Sunday, December 5, 2010

Rule #1 Analysis Blitz #5: Priceline (PCLN)


Up here in Toronto, winter, in my opinion, has not officially arrived, but it won't be long.  When the snow plows make their way around the city, that will be first day of winter for me.  Although I do enjoy winter, especially the snow, more than most other people, I don't mind vacationing in more tropical places either.  For our honeymoon, Renee and I went to Sardinia, Italy, which is sort of like the Caribbean of Europe, with clear, turquoise water and white sandy beaches.  We also went to Rome and got to meet the pope (if you call speaking with him for about 4 seconds "meeting")!  Anyway, I digress...Vacationing is a big part of life and for a lot of people, thousands of dollars are spent every year on this activity.  Naturally, I'd like to speak a little about a company in the travel industry.  Actually, I had a request from one of my good friend, John's fiancĂ©e, Joanna, to analyse this stock.

What Does Priceline Do?
Priceline is a pretty big name in the online travel industry.  However, from speaking with various people, I have found that it definitely has not reached saturation, as many still haven't heard of this website.  In case you haven't heard of them either, I'll give a brief overview of its core business.  Priceline.com started out as a website where you can book very, very cheap hotels.  It specialized in selling vacant rooms for big name hotels.

So, say a certain Hilton hotel in Toronto has about 50 unsold rooms for next Saturday.  Since Hilton is a big name with reputation for charging several hundred dollars per night, it probably doesn't want to sell the rooms too cheaply, lest travelers start to realize that prices tend to drop as the travel date gets closer.  Here's where Priceline comes in.  It helps Hilton sell the 50 rooms without anyone realizing that Hilton is selling these rooms for cheap.  So, if you were visiting me in Toronto next Saturday, you would go to Priceline.com and choose Toronto and Saturday as your travel date.  Priceline will then show you a list of hotels, its star rating, its approximate location, and its retail selling price.  You can then "name your own price" or basically bid for that room.  You can of course low ball and bid $25 for the room, but the catch is you can only bid once per day.  So, you can start off bidding $25 for a 4-star hotel, but chances are your bid would get rejected.  You would have to wait until the next day to bid again.  Eventually, you will realize you have 1 day left and still no hotel booking.  You would then bid an appropriate price, say, $90, and probably get accepted.  At that point, you find out which hotel has accepted your bid.  Wow!  Hilton in Toronto accepted your bid for $90!  That's roughly $210 saved!  One small caveat is that the booking fee is paid upfront and is non-refundable.

In the end, you have 3 happy parties.  First, you got an awesome room booked at a cost of $90.  Second, Hilton sold an otherwise unsold room and increased its revenue.  Third, and most importantly for us, Priceline gets a cut acting as an intermediary.  I can tell you that Priceline is one of the first websites I visit whenever I travel.  I once booked a 4-star Marriott in downtown Calgary for $65!  I then called Marriott and asked how much they were charging the same room for...$295!

Moat
You can download the completed Rule #1 spreadsheet here.

Let's take a look at the Big 5s to see whether Priceline has a moat.  The 9-year average doesn't look too good, but the 5-year and 1-year numbers look pretty solid.  If you look more closely at the spreadsheet, you get the picture that the company struggled in its early years but finally in the last 4 to 5 years, have figured out what makes them profitable.  Its earnings for the first 3 quarters of this fiscal year have already surpassed last year's earnings.  So, its growth doesn't seem to be slowing at any time soon.  With the economy slowly picking back up, you can only see a brighter future for the company.  All greens for the Big 5s and almost 0 debt makes for a company in a very good position.

Priceline's main competitor is Expedia, which is more of a household name than Priceline itself.  Hotwire, which is a site owned by Expedia, offers a similar service as Priceline.  Instead of letting you name your price, Hotwire shows you the price, the hotel's star rating, amenities and general area.  You can then choose to book the room and have the hotel revealed to you.  Similar to Priceline, you have to pre-pay the non-refundable booking fee.  From my experience, I enjoy using Priceline a little more because I get to choose the price, which in the end, may or may not save me more.  But the general experience has been better with Priceline.  However, Expedia does has a larger offering with better known sites such as Expedia.com, Hotels.com, Tripadvisor.com, Expedia CruiseShipCenters, etc.

Priceline's moat as shown by numbers is good, but this may attributed to secular, organic growth of the online travel industry.  Since Expedia's growth rates are similar to Priceline's, I can only guess that both companies are riding the same wave of growth in the sector.  There is a also little barrier to entry for other companies, so there is no real moat for Priceline.  It's name brand is good, but not even close to that of, say, Coca Cola.

Priceline gets a good score for its Big 5s, but gets a few points docked off for its inconsistent early years, and also lack of a real moat.  It gets a score of 7.

Moat Score: 7 / 10
Figure 1: Rule #1 Analysis of Priceline (PCLN)

Margin of Safety
My first reaction when I saw Priceline's stock price was "wow"!  I remember I had looked at the stock a couple of years ago and it was under $100.  The stock has grown quite a bit to $414!  It's P/E ratio is sitting at a lofty level of 45.  Just looking at this P/E tells me that the stock is probably fairly or overpriced.  

Let's look at the numbers.  The analysts estimate that Priceline's future growth will be around 23.8%.  I believe that may be a little optimistic.  I've dialed it back down to 20%.  I've also used a P/E of 25.  With these assumptions, I get an entry price of $177.54...quite a ways from its current $414 stock price.  If we were very optimistic and used a 25% growth rate with a P/E of 35, the entry price is $373.86, still below its current stock price.  It is seldom that a growing company can sustain a high P/E for a long period of time.  Thus, it is fairly clear that Priceline is a fairly or overpriced stock.  I'd like to see the price fall back down to low $200s before considering buying it.  We cannot afford to buy a stock without some safety margin, just like engineers would never build a bridge with a safety factor of 1 (essentially no safety factor).

Payback time with even a 25% growth rate is 9.9 years, a little high for my liking.

Priceline gets a score of 3 for Margin of Safety.

Margin of Safety Score: 3 / 10

Management
There is not much on Jeffrey Boyd, the CEO of Priceline, on the web.  He's been at the helm of Priceline for about 8 years.  As we spoke of earlier, the company turned around in the last 4 to 5 years and that can be attributed to Boyd's leadership.

He owns about $80 million worth of Priceline stock, which is not a bad, considering his salary and bonus amounts to about $2.5 million in a year.  So, he has vested interest in running the company well.  There hasn't been much trading lately.  He did exercise 100,000 shares worth of options in the summer and pocketed about $20 million from that transaction.  CEOs are smart people, and so they know when is a good price to sell shares to lock in some profits.  Selling is usually not a big deal, but does require us to look at the sale to see if we can find out anything suspicious.  In our case, I don't see any cause for concern.

Boyd's got a fairly long history with Priceline and has shown to be a capable leader by turning the company around.  All signs look good, but since there's not much information on him on the web, I will take a couple of points off just because there's uncertainty.  He gets a 8 out of 10.

Management Score: 8 / 10

Meaning
Priceline definitely has meaning for me and probably for any shrewd traveler.  I love its service and the savings I get from them.  I have used it multiple times for booking hotels and have never really had any problems.  The only "problem" I've had was that I had wrongly assumed that I was going to get 2 double/queen beds.  Priceline tells you pretty clearly that the rooms accommodates 2 adults, and no more.  I just thought that from previous experience, I would have no trouble getting 2 double/queens, but I was wrong.  I got 1 king bed instead.  We got over it since we had only 3 people in the room.  But clearly, it was my fault...so can't blame Priceline.

If you google "priceline unethical", what you get is a bunch of people complaining about Priceline's service.  As with all online hotel booking services, there will be occasional (un)intentional miscommunication between the hotel and Priceline.  What ends up happening is the customer gets inconvenienced, no matter what the resolution is in the end.  This is a matter of customer service.  Priceline probably has some work to do in this area and possibly needs to set better guidelines for communication with its hotel vendors.  Having said that, I did not find any real unethical activity.

So, I think we're good to go in this category.  I will say it again, "I love Priceline's service!"  I recommend it to all of my friends and would not hesitate in investing in the company based on the meaning category.  It gets a score of 8.

Meaning Score: 8 / 10

Summary
Moat Score: 7 / 10
Margin of Safety Score: 3 / 10
Management Score: 8 / 10
Meaning Score: 8 / 10
OVERALL (not an average): 4 / 10

Bottom line: If the share price comes down by about 50%, I would not mind owning this company!