Description

write-up was from one week ago. was going to post it after i come back from vacation, as i thought there was going to be little news to move the stock price. stock is up today, as a key part of the thesis may start to play out much quicker than i thought. still think the stock has a lot of upside from here.

For all my concerns on China macro and corporate governance, I think Ctrip is a good idea here. To call it washed out is an under-statement – this former darling fell from $50 to $13 in 12months, sell-side rating is 5 buy/13 hold/5 sells, and various sell-side notes noted recent meetings as “worst” meeting. This decline started from a fierce price war launched by the #2 player in hotel booking (40% of CTRP revenue) and wreaked havoc on CTRP’s margins. While near-term earning projection is tricky, investors are missing the fact that CTRP is holding market share, and the price war cannot last as competitors are on the verge of losing money. Revenue is still growing at 15-20%. At $14, CTRP is trading at 10x normalized EPS (2011 EPS prior to price war was $1.48), while net cash + investments is 50% of market cap. CTRP recently launched a $300m buyback program, and signed a partnership with #1 global OTA PCLN with a cash-rich balance sheet and potential needs to diversify away fromEurope. While the stock is in the doghouse and will be volatile in the near term, I think this will be a $25+ stock on 15x multiple, once the price war subsides and margin recovers. There is lots of uncertainty, but little price risk from here. A longer time horizon (2+ years) is needed. 

Background: CTRP is the largest online travel agent (OTA) inChina with close to 50% market share, with #2 player eLong at 8%. Revenue is roughly 40% hotel booking, 40% air travel, 15% packaged tour. Online travel accounts for 10% of total travel industry sales. With mix shift in economy, travel should naturally grow above GDP. Indeed, CTRP has posted 30%+ revenue growth for 10+ years, before slowing to 17-18% currently. Even with a potential slowdown/hard landing, I think the market and CTRP should grow 15%+ over the next 5-10 years. CTRP employs an agent model, i.e. it takes a cut in every hotel booking/ticket purchase. Unlike the pure online OTAs such as EXPE/PCLN, CTRP also has a large call-center to assist customers book travel over the phone and deliver tickets in person. CTRP has one of the highest customer satisfaction scores inChina and has built a loyal customer base esp. in corporate travel who values service more than pure price. Business customers make up 70-80% of mix according to the company.

Competition: The high growth rate combined with a 35%+ op margin naturally attracts competition, coming from several fronts. First and foremost it comes from eLong, a perennial #2. eLong has been growing slower than CTRP, and it all but gave up air travel to concentrate on hotel booking. In 2011, it received a further investment by Expedia, who now owns 30% of eLong. eLong then launched a coupon campaign, where anyone who booked hotel rooms through their website gets a 50RMB coupon, which mostly appeals to budget conscious travelers. CTRP initially under-estimated the impact of the coupon, and eLong took some market share. So in Q3 ’11 (November), CTRP announced that they would match the coupon. Mgmt refused to disclose how much of the hotel booking uses coupons, but a reasonable guess is that it probably applies to around 30% of total bookings, and neither company makes much money on those bookings on those coupons (could even lose a bit). The coupon alone took 500+bps of margins off CTRP’s op margin, and along with some other SG&A investments for new products, took 1000+ bps from CTRP’s P&L in FY ’12.

There are a couple of important points here. First, after CTRP responded to the coupon, market share has stabilized, so there is really little economic incentive for eLong to keep the price war. Indeed, eLong saw its own op margin contract from 10% to near break-even. However, eLong mgmt has indicated they will keep the coupon for the foreseeable future and do not care much about P&L. CTRP has come back and announced they are setting aside $300m of cash for potential price wars. I think this is just a poker game where each player is trying to bluff away the other player, and eventually both will come to their senses. For comparison, CTRP has over 5B RMB of cash vs. eLong at 2B. Net sales is 5x larger, hotel booking is 2x while air ticket is 14x. eLong does have a deep-pocketed backer in Expedia, but I do not expect a public company like EXPD to bankroll eLong to a hopeless price war for ever. In the mean time, CTRP has just launched a partnership with PCLN (4x larger than EXPE) with a cash heavy balance sheet. I doubt CTRP mgmt is willing to sell at this low price, but it is another signal to eLong and other competitors.

Then there are various other competitors, including Qunar (backed by Baidu) and Taobao. Still, OTA is a scale business, and I doubt these new comers with their small market share can really mount much of a challenge to CTRP over the long run. There is a competing model causing some near-term pain on CTRP – there are a bunch of mom-n-pop wholesalers that buy hotel inventory at much lower price from hotels directly and then resell it on Taobao/Qunar websites. CTRP does not take any inventory, so it cannot compete on price against these wholesalers. This has become a more serious issue for CTRP as the economy slows down, and there is excess hotel room inventory. In the longer term, however, hotels are aligned with CTRP in that they do not want to under-sell themselves. I think the dynamic will improve as the hotels get better at managing their own inventory and find better balance among distribution channels.

Net net, I think competition risk is real but overblown, as the price war in hotel booking cannot last forever. It is also important to realize CTRP has virtually no competition in airline booking (40% of revenue), and has consistently out-grown airline industry booking growth. Take rate in that segment is very similar to global peers.

Valuation: Even with 17% revenue growth this year, CTRP is seeing EPS down 28% this year, as op margin collapsed from 35% to 17-18% range (coupon, SG&A investment, new products) Note out-year estimates only assume margins recover to 20% level, a far cry from previous margins and PCLN’s 30%+ level. Even on these reduced expectation, CTRP is trading at 10x ’14 with 15% topline growth. Yet the company has 830m USD of cash and $180m investments in two publicly traded Chinese lodging companies (HTHT and HMIN). So combined cash and investments are over 50% of current market cap of just under $2B. Note CTRP got the shares of HTHT and HMIN as initial VC investors – CTRP founders are serial entrepreneurs with a proven track record of building viable businesses. I happen to think HTHT and HMIN are both well positioned and shares could be under-valued at current prices (both are off 50%+ of peak). Therefore, I think CTRP is cheap on P/E ex-cash, and stock could work if 1) margin recovers, 2) strategic investors emerge.

Catalyst