NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the Issuer Default Rating (IDR) for Expedia, Inc. (Expedia) at 'BBB-', affirmed the senior unsecured debt rating at 'BBB-', and assigned a 'BBB-' rating to the new senior unsecured notes. The Rating Outlook is Stable.
In July 2014, Expedia entered into an agreement to acquire Wotif.com Holdings Limited for a USD equivalent of $658 million. Wotif is a leading online travel agent (OTA) in Australia and operates in the APAC region. Through the transaction, Expedia gains market share and local inventory while Wotif benefits from Expedia's technological expertise. Proceeds from the new notes are expected to be used for general corporate purposes, including funding the acquisition of Wotif. The company has historically issued debt to fund share repurchases or around the time of acquisitions.
Fitch calculates unadjusted leverage of 1.3x at June 30, 2014, and pro forma for the new notes, high 1.0x to low 2.0x. Fitch expects leverage to decline on absolute EBITDA growth. There is room at the current rating level for leverage to spike above 2.0x due to strategic acquisitions, so long as Fitch views the transaction as favorable and is comfortable that leverage will be reduced within a 12-18 month period. Fitch forecasts leverage to be around 2.0x or below at the end of FY2015.
As the competitive and technological landscape continues to change, traditional OTAs will vie to increase their global share and maintain their relevance in the face of other travel providers moving down the purchase funnel (i.e. TripAdvisor's instant book). Fitch expects Expedia to continue growing organically and by acquisition, possibly operating closer to the 2.0x leverage range than it has in the last few years.
KEY RATING DRIVERS
Expedia's ratings reflect its solid credit profile and reasonably conservative balance sheet offset by event risk concerns. The company has significant exposure to economic cyclicality through its impact on travel demand which is countered by strong secular growth trends as an increasing mix of travel reservations are made through OTAs. Expedia's leading market position as an OTA is a significant credit strength enhanced by its solid geographic and customer diversification. Event risk concerns are material and reflect Liberty Interactive's (Liberty) controlling stake in the company (although its shares are voted by Expedia Chairman, Barry Diller).
In March 2012, Liberty affected a sale of 12 million shares, approximately 35% of its total economic interest in the company although it retains control of 56% of the voting shares. In the event that Expedia did pursue a debt-financed repurchase of the remaining Liberty stake, it would be difficult for the company to retain its investment-grade rating and/or a Stable Outlook, given limited headroom in the rating today. Fitch expects the company to delever over the next one to two years, creating additional headroom, increasing its ability to retain its rating and Outlook in the event of a debt-financed repurchase of Liberty-owned shares.
Fitch continues to believe that Expedia's credit profile is weaker following the 2011 spin-off of TripAdvisor which provided Expedia significant revenue diversification and could potentially evolve into a more direct competitive channel for hotel bookings. There is execution risk at Expedia as TripAdvisor's business evolves considering its significance as Expedia's largest marketing partner. However, Expedia's 2013 acquisition of trivago, and its subsequent growth, acts to considerably offset the loss of revenue diversification from the TripAdvisor spin. In the LTM period ended June 2014, revenues from Ad and Media grew to $415 million; prior to the TripAdvisor spin revenue was $476 million (LTM ended June 2011).
Fitch expects that Expedia will remain a moderately leveraged credit while the competitive landscape and changing technology trends of the OTA market remain in flux. TripAdvisor's new mobile Instant Booking feature blurs the line between the metasearch function and the OTAs. Expedia and Priceline have not partnered with TripAdvisor on this new feature; Fitch believes that is due to the risk of commoditization of the OTA function as merely a back-end transaction processor in the minds of consumers. Google's intent in the travel market and the ability and willingness of hotels to compete for direct bookings are both considerable long-term threats. Fitch views Expedia, as one of the largest OTAs in the world with a meaningful secular tailwind and significant financial flexibility, as having the capacity to manage these potential challenges over the foreseeable future.
The company's strategic decision to broadly offer consumers the choice to pay upfront for hotels under a merchant model or pay at the time of a stay under an agency model has only modestly impacted cash flow, as Expedia has maintained a controlled roll-out of this new feature. Fitch expects it will increase Expedia's traction with both consumers and new hotel acquisitions at a manageable expense-to-cash flow during what will likely be a multi-year transition. As of June 2014, over 59,000 of Expedia's 325,000-plus hotel partners have chosen to give consumers this option as part of the Expedia Traveler Preference (ETP) program.
Expedia's recent results highlight the secular tailwinds in the OTA environment. For the second quarter 2014 (2Q'14; end June 2014), revenue increased 24% over the prior year period. Revenue growth has accelerated on the back of strong hotel signings on the ETP platform. More significantly, 2Q'14 EBITDA margins strengthened from strong revenue growth and leveraging of fixed costs. Expedia plans on investing more in sales and marketing and salesforce to drive acceleration of hotel acquisitions in 2H'14. However, EBITDA margins have been trending lower on a longer term basis. EBITDA margin for the LTM period ended June 2014 was 18.1%, down from 20.5% in FY2011, reflecting competitive pressures and shifts in the market. Other factors which impacted margins include Expedia's shift to an ETP platform for hotels; the agency model is lower margin. Expedia's Hotwire business continues to underperform, the result of both competition (e.g. Priceline's Express Deals) and tight hotel inventories. In fact, tight hotel inventories generally compress margins across all of Expedia's platforms.
Fitch believes these challenges reflect the potential execution risks inherent in the business as technology and consumer preference shifts the OTA landscape. Expedia spun off TripAdvisor in 2011 which Fitch believes may eventually result in TripAdvisor evolving into more of a direct competitive threat. Separately, Expedia acquired Trivago in early 2013 for its hotel metasearch capabilities, which Fitch views as a response to competition from the likes of Kayak. Expedia remains one of the largest OTAs in the market but as the industry churns through what is a new wave of technology evolution, these risks will add volatility to results and could ultimately alter its standing in the marketplace. To date, management has been reasonably proactive in positioning the company for the future while also maintaining solid credit metrics.
Credit strengths include:
-- 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 toward 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 have a negative effect on the company's competitive position.
Ratings concerns include:
-- Increasing competition from other on-line travel businesses including Google as well as the potential for non-OTAs such as TripAdvisor to become significant competitors in the future;
-- Expedia faces a potentially significant contingent liability due to lawsuits related to hotel occupancy taxes. The company could also face negative pressure on profitability if municipal tax rules are amended to apply specifically to the retail rate charged by Expedia;
-- Ongoing pricing pressure in the OTA market combined with increasing competition with direct sales channels could negatively affect future revenue growth and profitability;
-- Inherent volatility in travel service demands from macroeconomic drivers as well as the potential for significant volatility due to travel demand shocks;
-- Liberty Interactive holds shares representing approximately 56% of the voting power in Expedia. 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;
-- In a slower growth or negative revenue environment, the working capital deficit of $3.8 billion at June 2014 is expected to be a use of cash;
-- 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. Fitch believes, however, that OTAs represent a valued source of market information to, as well as being a marketing arm of, travel service providers.
Liquidity as of June 30, 2014 was solid with $1.4 billion in cash and an undrawn $1 billion senior unsecured revolving credit facility which expires in November 2017. Free cash flow has averaged near $600 million annually for the past five years, which Fitch expects to remain similarly strong in 2014 and 2015. Expedia has a working capital deficit of $3.8 billion which peaks seasonally in the June quarter and should decline through the end of the year by utilizing approximately $600 million to $800 million of the company's existing cash balance. Expedia does have $2.4 billion in total cash and short-term investments to partially offset the working capital deficit.
Total debt as of June 30, 2014 was $1.2 billion and consisted of $500 million in 7.456% senior unsecured notes due August 2018 and $750 million in 5.95% senior unsecured notes due August 2020.
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
--Fitch believes there are minimal business considerations to support the company maintaining a rating above 'BBB-' which will likely forestall positive rating action for the foreseeable future. However, a more conservative financial profile coupled with increased revenue diversification from the growth of the Egencia segment and Ad and Media revenues could have positive implications for the rating.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-- An increase in expected volatility in profitability, potentially due to greater volatility in travel services demand or a higher fixed-cost component to Expedia's financial model;
-- A secular decline in the OTA business model, potentially resulting from a shift in the competitive landscape;
-- A substantial financial loss from any future conclusion of the occupancy tax lawsuits facing the company;
-- A more aggressive financial policy, reflected through material debt-funded acquisition, share repurchase (including buyback of Liberty-owned shares), or dividends, that drive leverage sustainably above 2.0x.
Fitch has taken the following rating actions for Expedia:
--IDR affirmed at 'BBB-';
--Senior unsecured bank credit facility affirmed at 'BBB-';
--$500 million in 7.456% senior unsecured notes due August 2018 affirmed at 'BBB-';
--$750 million in 5.95% senior unsecured notes due August 2020 affirmed at 'BBB-';
--New senior unsecured notes rated 'BBB-'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria & Related Research:
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014),
--'Expedia, Inc.' (Aug. 13, 2014)
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage