Fitch Affirms Expedia's IDR at 'BBB-'; Outlook Stable
KEY RATING DRIVERS
Expedia's rating reflects its solid credit profile and reasonably conservative balance sheet, offset by growing competitive pressures and event risk concerns. The company has significant exposure to economic cyclicality through its impact on travel demand. However, this is countered by the secular tailwinds as an increasing mix of travel reservations are being made through online travel agencies (OTAs).
Expedia has been growing its international presence and diversifying its revenue geography over the past few years (46% of total revenue for last 12 month (LTM) period ending June 30, 2015). This has been helped by strategic acquisitions such as the 2014 Wotif.com Holdings purchase (largely debt-funded). Additional revenue diversification has come in the form of ad and media revenue (9% for LTM period) following Expedia's purchase of a stake in trivago in 2013.
In February, Expedia entered into an agreement to acquire Orbitz Worldwide for $1.6 billion. The company raised EUR650 million in unsecured notes in May to fund a portion of the acquisition. Expedia also received additional liquidity from its May sale of its stake in eLong, Inc. for roughly $671 million, though the ultimate use of these proceeds remains unclear.
Fitch calculates pro forma leverage of 2.0x at June 30, 2015 for both the Orbitz and eLong transactions. The eLong sale already closed and the Orbitz transaction has been approved by both boards of directors and Orbitz shareholders, although regulatory approval is still pending. 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 1.8x or below at the end of fiscal year (FY) 2016.
The Orbitz transaction falls within this context and Fitch views it as strategically sound, as larger competitors within the industry benefit from economies of scale and smaller players are increasingly unable to compete as effectively on items such as marketing and technology spending. The pending merger is being reviewed by the Department of Justice and each company received a request for additional information and documentation in March. The combined entity will comprise a majority of U.S. OTA bookings; however, represent a much smaller piece of the overall $1.3 trillion global travel market. OTAs are experiencing increasing competitive pressures from direct hotel and air suppliers, as well as non-traditional players like TripAdvisors' Instant Book.
In regards to the eLong sale, divestitures have not been a common occurrence under management's current strategy. Fitch believes Expedia can maintain commercial relations to continue sourcing supply through eLong while also providing global supply, maintaining access to the China market. However, the terms of the commercial agreement and how it evolves over time are unclear and is complicated due to Ctrip's affiliation with Priceline. Additionally, the asset sale clouds the company's strategy with respect to the China market. One near-term benefit from the asset sale is the elimination of a roughly $95 million EBITDA drag for Expedia for the LTM period.
Another upcoming potential use of cash is the call option on Trivago in the first quarter of 2016 (1Q16), whereby Expedia can purchase up to 50% of the minority shares. Expedia currently owns 63% of Trivago and the redeemable non-controlling interest balance was carried on its balance sheet at $558 million as of June 30, 2015.
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, Google reportedly testing similar functionality). Fitch expects Expedia to continue growing organically and by acquisition. However, there is now less headroom for any additional leveraging transactions, including material debt-funded acquisitions or return of capital to shareholders.
CREDIT STRENGTHS
Credit strengths include:
--Expedia is one of the largest OTAs 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.
RATING CONCERNS
Ratings concerns include:
--Increasing competition from other online travel businesses including TripAdvisor & Google, as well as the potential for non-traditional suppliers such to evolve into significant competitors in the future;
--Expedia faces a potentially significant contingent liability due to lawsuits related to hotel occupancy taxes;
--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 57% 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 Fitch-defined net working capital deficit of $4.7 billion at June 2015 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.
KEY ASSUMPTIONS
Fitch's expectations are based on the agency's internally produced, conservative rating case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate. Key Fitch forecast assumptions include:
--Strong revenue growth in the double-digit range driven by organic growth and continued strategic acquisitions.
--EBITDA margins hold steady in the 17%-18% range through leveraging of fixed costs on aggressive revenue growth offset by the levels of investments in sales and marketing expense that support a longer term view.
--No additional debt raised through the forecast period as future acquisitions are in the $400 million range and funded through cash flow from operations.
--Share repurchases of $550 million annually, consistent with 2014 gross levels, and steady dividend increases consistent with 2014 payout ratio.
--Orbitz transaction closes in second half of 2015.
RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
--Positive rating action will likely be forestalled for the foreseeable future due to minimal business considerations to support the company maintaining a rating above 'BBB-' and certain secular challenges. These include an intensifying competitive environment, shifting consumer behaviors, and technological shifts. 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 the result of a shift to direct bookings with travel providers;
--The potential for 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, or dividends that drive leverage sustainably above 2.0x.
LIQUIDITY AND DEBT STRUCTURE
At June 30, 2015, Expedia had $3.2 billion in cash and generated $832 million in Fitch-defined free cash flow (FCF) during the LTM period. With FCF expected to be in the $900 million - $1.2 billion range, Fitch believes Expedia will be able to continue capital returns to shareholders at a pace similar to 2014 while maintaining pro forma leverage around 2.0x or below (Expedia paid $85 million in dividends and repurchased $538 million of shares on a gross basis during 2014). If operating performance is weaker than expected, Fitch expects Expedia would consider reallocating capital from share repurchases to debt reduction in an effort to remain within the current rating.
Total debt as of June 30, 2015 was $2.5 billion and consisted of senior unsecured notes maturing from 2018-2024. Expedia also has a $1 billion undrawn revolver that matures September 2019.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Expedia, Inc.
--IDR at 'BBB-', Outlook Stable;
--Senior unsecured bank credit facility at 'BBB-';
--$500 million in 7.456% senior unsecured notes due 2018 at 'BBB-';
--$750 million in 5.95% senior unsecured notes due 2020 at 'BBB-';
--EUR650 million in 2.5% senior unsecured notes due 2022 at 'BBB-';
--$500 million in 4.5% senior unsecured notes due 2024 at 'BBB-'.
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