Turbulence, Yes…Crash Landing, No – Upgrading EXPE To Buy – Citigroup

Citigroup’s Internet Retail team is upgrading Expedia (NASDAQ:EXPE) to Buy from Hold with a $29 price target (prev. unch), representing 38% upside.

Since late-October, Expedia’s shares have materially underperformed the market, declining 28% vs. a same-period increase in the S&P 500 of 12%. EXPE has been the worst performing stock in Citi’s Internet coverage space. The firm believes at least five factors have been behind this underperformance: 1. Uncertainty due to the dispute with American Airlines, which has stopped providing its inventory to Expedia; 2. Risk to TripAdvisor’s growth due to the select displacement of TripAdvisor in Google Organic Search rankings by Google Places results; 3. Concerns over the growth outlook of EXPE’s Hotel Merchant Model in North America, given the potential rise of competing Agency models; 4. The pending Google-ITA merger and concerns that this could increase the competitive complexity facing all Online Travel Agencies; and 5. EXPE’s issuance of below-Street-expectations single-digit OIBA growth for 2011, due to heavier than expected investment plans.

According to Citi, trading at 11X 2011 P/E with a 12% FCF yield, EXPE presents as the Best Value Play among Internet stocks. 4 Key Upgrade Factors:

1. Despite Steep Competition, EXPE’s U.S. Share Has Actually Increased — Vs. Priceline and Orbitz, EXPE’s Domestic Bookings share increased from 54% in 2009 to 55% in 2010. EXPE’s International position isn’t as strong, but still accounts for 36% of its total bookings and is growing a very healthy 25% Y/Y.

2. EXPE’s TripAdvisor Faces Disintermediation Risk, But Remains A Very Solid Growth Asset — TripAdvisor (13% of revenue, 20% of profits) has experienced a deceleration in its traffic growth due in part to the impact of Google Places. But the firm believes TripAdvisor can continue to deliver solid double-digit revenue growth given that a majority of its U.S. traffic is non-Google based, and TripAdvisor & Expedia still rank among the top Organic Search results in almost 90% of Citi’s study results.

Citi’s proprietary review of TripAdvisor and Expedia’s rankings in Google’s Organic Search results for a series of U.S. hotel destinations actually shows a very strong presence. The details are in the exhibit below, but out of the 30 Searches they conducted, TripAdvisor showed up in the top 3 Organic Search results 50% of the time. Meanwhile, Expedia showed up in the top 3 Organic Search results 70% of the time. Which means that Expedia or one of its properties showed up in the top 3 Organic Search results a very high 87% of the time. This is a very strong presence.

3. Channel Checks Show No Change In EXPE’s Merchant Model Appeal — A recent concern has been that EXPE’s attractive cash flow Merchant Hotel model might be under pressure from competing Agency models. Citi’s extensive checks with Hotel suppliers and other OTAs has uncovered no evidence of this. They believe EXPE’s blended Merchant & Agency global approach remains well intact.

4. Industry & Financial Catalysts Are Identifiable — Citi believes a negotiated outcome with American Airlines is likely in ’11 and notes this is not factored into ‘11 estimates. B. EXPE has a consistent track record of share repo’s, and current valuation could trigger a larger than normal financial catalyst.

Throughout 2010, EXPE bought back 20.6MM shares for an aggregate purchase price of $489MM (as at average price of $23.71 per share). Further, EXPE currently has about 19.4MM of repurchase activity/authorization still available, which amounts to about 7% of shares out.

Notablecalls: With EXPE you have the following situation:

– Beaten down stock, down 40% in a fairly short time. One of the sector leaders.

– Several problems, many of them appear fixable at to least some extent. Citi believes the American Airlines dispute will have a negotiated outcome in 2011. Based on their work and on the work of Citi Airlines Analyst Will Randow, they believe the dispute has been detrimental to both companies.

– Citi highlights the co still has buyback authorization for 7% outstanding. That should support the stock.

Citi was smart enough (or lucky enough) to downgrade it back in October, near the highs, so the call will get attention.

The tricky part here is how to trade it. It’s going to open @ 22 bucks, which is +5%. Not sure you want to buy it there. Wait for a pullback & then possibly ride it to 22.50+. (provided the mkt holds up).

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