NEW YORK--(BUSINESS WIRE)--Fitch Ratings has placed the following ratings for Expedia, Inc. (Expedia) on Rating Watch Negative:
--Issuer Default Rating (IDR) 'BBB-';
--$500 million in 7.456% senior unsecured notes due August 2018 'BBB-';
--$750 million in 5.95% senior unsecured notes due August 2020 'BBB-';
--Senior unsecured bank credit facility 'BBB-'.
The rating on the 8.5% senior unsecured notes due July 2016 is affirmed at 'BBB-' with a Stable Outlook. Fitch believes these bonds are protected from the proposed divestiture due to a restricted payment clause in the underlying indenture and may need to be either repaid or amended.
Expedia is proposing a tax-free spin-off of its TripAdvisor business to existing shareholders. Significantly, the proposal will mirror the current ownership structure in both entities including Liberty Media's voting control and Expedia Chairman Barry Diller's proxy to vote those shares. This has been and continues to be a credit concern for Expedia and has historically limited the IDR to 'BBB-' despite leverage under 2 times (x) and a leading competitive position. Fitch effectively factored in the probability of debt financed transactions given Liberty's voting control. Fitch believes that this proposed transaction is a more significant negative event for bondholders than what had been previously incorporated into the rating.
The Rating Watch Negative reflects Fitch's belief that TripAdvisor is a significant contributor to the overall credit quality of Expedia. This reflects the diversification of revenue TripAdvisor contributes as well as its much higher growth rate and EBITDA margin. Expedia bondholders are left with a weaker operating entity with much reduced growth expectations going forward if the divestiture proceeds as proposed.
TripAdvisor as a stand-alone entity will likely represent a significant new competitor to Expedia. Fitch believes that TripAdvisor will now have much more flexibility to pursue a model akin to competitors such as Kayak that can promote hotel direct bookings in favor of directing traffic to on-line travel agencies (OTA) such as Expedia.
Fitch believes this transaction impacts the heart of Expedia's model, which is merchant-based hotel bookings. Lost in the confusion of the recent American Airlines dispute is the fact that the large majority of Expedia's revenue comes from hotel bookings which is significantly higher margin business than air ticket bookings. Within the hotel business, merchant bookings, which are the majority of Expedia's hotel business, have both higher margin and favorable working capital trends relative to agent model bookings. The merchant booking model is dominant in the U.S. hotel market, and Fitch believes this is really the heart of Expedia's business. TripAdvisor is very complimentary to Expedia's U.S. merchant hotel bookings business as a combined entity and a significant threat as a stand-alone company.
The Rating Watch is not driven by the change in credit metrics for the proposed divestiture. Pro forma for the divestiture, Fitch estimates that leverage would increase from 1.7x to approximately 2.3x. This assumes that the full amount of Expedia's current debt outstanding of $1.65 billion would remain with Expedia. Fitch estimates that 2010 operating income before amortization would decline from $831 million, as reported for the combined entity, to approximately $600 million for Expedia ex-TripAdvisor. Fitch estimates that mid-single digit EBITDA growth in 2011 for Expedia ex-TripAdvisor would reduce forward looking leverage modestly but remain above 2x (assuming all debt remains at Expedia). Fitch had historically viewed Expedia's rating within the context of the entity having leverage up to 2x and these pro forma estimates are not significantly outside that view.
What is significant is that Fitch's previous 2011 estimated EBITDA growth for the combined entity reflected an expectation of mid-single digit growth for Expedia ex-TripAdvisor and 20% to 40% growth for TripAdvisor. In Fitch's view, the proposed transaction would leave bondholders with an entity that has mid-single digital growth potential but a potentially materially weakened competitive position.
Fitch believes that the low growth profile of Expedia ex-TripAdvisor will increase event risk associated with debt financed shareholder friendly actions going forward.
Fitch expects to resolve the Rating Watch Negative when the proposed divestiture is either affected or withdrawn. The company has indicated it expects to complete the divestiture in the third quarter 2011. Fitch believes that the ratings could be lowered by one notch to 'BB+' based on current information and estimates. The ratings could be maintained at the 'BBB-' level if, among other things, the company was to redeem a portion of its debt outstanding and indicate it would maintain lower leverage for Expedia ex-TripAdvisor going forward.
On a positive note, Expedia ex-TripAdvisor will continue to have numerous credit strengths that contributed to its investment grade rating. This includes:
--Strong and relatively stable cash flow positively impacted by favorable working capital flows during periods of growth but, conversely, these working capital flows are a cash drain during revenue declines.
--Expedia is the largest OTA with advantages in scale that have contributed to the company gaining significant share in the market for travel services over the past several years.
--Broad customer and geographic diversification positively impact the stability of end-market demand for travel services which are inherently highly correlated to the macro-economic environment.
--Expedia benefits from the expected continuation of a secular shift towards use of OTAs which should support revenue growth in excess of both overall travel services and GDP growth.
--A relatively high variable cost model limits potential negative pressure on profitability during business downturns, although much of the variable cost items are specific to marketing expense which, if reduced, could negatively impact the company's competitive position.
Ratings concerns include the following:
--History of debt financed share repurchase programs.
--Expedia's largest shareholder is Liberty Media Corporation, which holds shares representing over 60% of the voting power. While Liberty has given Expedia's Chairman of the Board Barry Diller a proxy to vote these shares, Fitch's ratings take into account Liberty's historical track record of shareholder-friendly actions.
--Google's proposed acquisition of ITA Software, a global distribution system (GDS) supplier to the OTA market, could enable Google to become a significant competitor to Expedia. In addition, TripAdvisor is facing increased competition from services such as Google Places which is forcing the company to increase its investment in the TripAdvisor business, negatively impacting margins.
--Expedia faces a potentially significant contingent liability due to lawsuits related to disputed hotel occupancy taxes.
--There is risk of volatility in Expedia's competitive position due to minimal differentiation between competing OTAs as well as low switching costs for end-users, partially mitigated by Expedia's advantage in scale as its bookings are approximately twice that of its nearest competitor.
--Inherent volatility in travel service demands due to macroeconomic drivers as well as the potential for significant volatility due to travel demand shocks.
--Expedia competes directly with the online presence of its suppliers in the travel services industry, which could lead to future disruptions in the company's business model, although Fitch believes OTAs represent a valued source of market information to, as well as being a marketing arm of, travel service providers.
Liquidity as of Dec. 31, 2010 was solid with $714 million in cash and an undrawn $750 million senior unsecured revolving credit facility which expires in August 2014. Expedia also had $516 million in short-term investments. Additionally, free cash flow has averaged near $500 million annually over the past five years which Fitch expects to remain similarly strong in 2011.
Total debt as of Dec. 31, 2010 was $1.6 billion and consisted of i) $395 million in 8.5% senior unsecured notes due July 2016; ii) $500 million in 7.456% senior unsecured notes due August 2018; and iii) $750 million in 5.95% senior unsecured notes due August 2020.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', dated Aug. 13, 2010;
--'Recovery Ratings and Notching Criteria for Nonfinancial Corporate Issuers' dated Nov. 24, 2009;
--'Liquidity Considerations for Corporate Issuers', dated June 12, 2007;
--'Cash Flow Measures in Corporate Analysis', dated Oct. 12, 2005.
Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=546646
Recovery Ratings and Notching Criteria for Nonfinancial Corporate Issuers
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=489006
Liquidity Considerations for Corporate Issuers
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=328666
Cash Flow Measures in Corporate Analysis
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=243758
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