Description

Liberty Expedia split off from Liberty Ventures on Friday, November4th.  The split had been in the works for over year - it was announced last November at the Liberty investor day.  The purpose of the split was twofold: 1) to separate the two largest assets inside of Liberty Ventures to give investors the ability to value the assets separately, and 2) to faciliate a merger of Expedia control shares owned by Liberty into Expedia.

Today, Liberty Expedia is trading for an almost 17% discount to NAV, one of the widest in the Liberty complex, despite being incredibly simple entity and having a relatively short "fuse" for the discount to close.  I believe LEXEA offers ~20% upside over the next 12-18 with very limited risk by shorting owned shares of Expedia against the position.  Further, for those like me who like the underlying EXPE business, I believe there is as much as 46% upside as underlying EXPE goes to $145 / share over the next twelve months (or ~18x  2018 esitmates of $7.90 / share).

Brief History

Liberty Media (later Liberty Interactive) recieved shares in Expedia in 2005 after it was spun out of IAC Interactive.  Due to its ownership in IAC, Liberty received 10m "A" shares and 12.8m "B", or controlling, shares.  Liberty has 16.7% of the total shares outstanding of EXPE, but through the B shares, Liberty has over 52% of the vote.  At the time of the spin, Liberty granted Barry Diller its proxy to vote the B shares for as long as Barry stays the Chairman of Expedia (effectively giving Barry control).  The proxy passes back to Liberty on Barry's incapacitation.  Liberty has other rights, like the ability to vote in 20% of the BoD (John Malone is on the Board now), and maintain ownership by buying more shares from the company at the same effective price as employees who were issued stock options (so Liberty would not get diluted).

As part of the creation of Liberty Expedia, John Malone and Barry Diller entered into a proxy swap agreement that lasts for 18 months.  Barry is giving his proxy to vote the B shares of Expedia to Liberty Expedia.  Because of this, LEXE will consolidate EXPE's results.  Malone gave Diller his proxy to vote the LEXE B shares, which gives Barry control of LEXE.  Confused yet?  All that happened is Malone and Diller agreed that Diller would stay in control of the EXPE vote, but that he'd do it through Liberty Expedia.  Essentially, this is a lead in to EXPE acquiring LEXE in the near term, putting the underlying EXPE shares in hands of Liberty holders in a tax efficient way - something John Malone has perfected.

Liberty Expedia Breakdown

The analysis for Liberty Expedia is very simple:

12.799 million EXPE "B" supervoting shares

10.807 million EXPE "A" shares

23.607 million total EXPE shares

There are 57.5m shares of LEXE outstanding, which means you're getting 0.410 shares of EXPE for every share of LEXE you own (worth about $48.80)

Liberty Expedia has an 'Active trade or business' called Bodybuilding.com; historically the business has grown at a healthy clip and expanded margins.  The last twelve months have seen increased competition, lower sales, and lower margins.  On a trailing basis, the business generated about $29m of EBITDA.  I believe that is conservatively worth 9x, or $260m.  That is about $4.50 / share to LEXE.

Liberty Expedia has net debt of $326m ($350m margin loan and $26m of debt at Bodybuilding.com, offset by $50m of cash).  That is about $5.65 / share in negative value to LEXE.

EXPE of $48.80 + BB.com of $4.50 - Net Debt of $5.65 = NAV of $47.65.  Stock is trading for $39.85, or 16.4% discount.

The Opportunity

The split of Liberty Expedia from Liberty Ventures will ultimately lead to Expedia buying Liberty Expedia.  This accomplishes two goals.  For Malone, this puts EXPE shares in the hands of Ventures holders, who can chose to own it or sell it (this is classic Malone).  For Diller, acquiring Liberty Expedia allows him to control the destiny of the company after he is no longer there.  Win win.

The earliest this can happen is one year and day after the split (so 11/5/17).  The proxy agreement ends after 18 months (May of 2018) which puts a "fuse" on the deal.  My guess is it will be closer to the former than the later, but either way the spread is too wide.

If it closes in a year, the IRR is 19.7%

If it closes in 18 months, the IRR is 12.8%

EXPE does pay a small dividend, which adds ~43c per LEXEA share per year (or +1.1%) to the IRR not included above.  The risk of course is in Bodybuilding.com (each turn of EBITDA adds / subtracts 50c per share, or about 1.3%). 

There is incremental upside too.  Historically "B" shares have commanded a premium - and there is a chance that Liberty Expedia holders get a kicker for their supervoting shares.  I believe that could be +10% or more on the 12.799m shares (+$150m in total), or $2.65 / share (+6.6%).

Expedia.com

Expedia is the largest OTA (online travel agent) in the world with over $71B of trailing gross bookings.  The OTA business model isn't the best that you'll ever come across, but it does have a lot going for it, namely that travel is growing as a percentage of consumer spending, and OTAs are growing their share of the travel market (EXPE believes that online booking accounts for just 45% of the total travel market today).

Expedia acquires web traffic through marketing channels and through google searches.  The company then works to convert that traffic into customers by giving them lots of hotel and flight options at low prices (both individually and bundled).  When customers book with Expedia, the company gets a fee from the airline, car rental company or hotel.  In total that number was about 12c per booking dollar over the last twelve months (significantly more for Hotels than airlines).

A lot of that money gets reinvested back into customer acquisition (6c per booking dollar) and technology (2c), but about 2c of that gross booking dollar converts to EBITDA.

Expedia's advantage, they say, is the technology platform they have built, and the network effects they have from the amount of inventory built up in the system over time.  The technology platform allows them to better convert traffic to sales - and in the legacy businesses, booking growth was +11% (accelerating throughout the quarter and into 4Q).  Add to that several (seemingly successful) acquisitions the company has made over the last two years and reported booking growth was 21%.  

Looking forward, the business should grow revenue in the mid to high teens over the mid term.  Core growth in the mid teens with small expansion of the fee per dollar as more of the traffic shifts to hotels from airline.  Higher revenue per booking dollar should allow EBITDA margins to expand somewhat (~50bps) over that period allowing for EBITDA growth north of 20%.  The reported numbers in 2016 / 2017 / 2018 should be a little better than that given prior acquisitions where synergies and growth are driving above average results.

For 2016, management is guiding to "approach the midpoint" of 35-45% EBITDA growth.  I'm on the conservative side with $1.6B of EBITDA (+37.5%) and $4.65 / share of adjusted EPS.  Next year, as their most recent acqusition (AWAY) bears more fruit and the core business continues to grow, I'm just over $2B in EBITDA and adjusted EPS of about $6.75 / share.  By 2018, the AWAY acquisition should see full synergies, and when combined with growth in the core business, adjusted earnings per year should approach $8.00 / share.

Given the growth profile, the business has always traded for a premium multiple; 15x earnings on the low end to almost 30x earnings in 2015.  At 18x earnings (S&P 500 +), on $7.90 in EPS the shares are worth $145 in 12 months (at least), or +22% from current levels.

LEXE captures 41c of every dollar more in EXPE, so $145-$119 = +$26 for EXPE or +$10.66 to LEXE.  That's +27% on the current price of LEXEA, and brings the entire return to +46%. 

Summary

LEXE shares offer +20% upside as an arb investment over the next 12-18 months.  Alternatively, through LEXE today you can create EXPE for just under $100 / share; which is attractive relative to my view of fair value at around $145 / share in 12 months.

Please hit me up with any thoughts / questions that you have.

Catalyst

Liberty Expedia

Nov 2016 to May 2017, Expedia acquires Liberty Expedia for stock

Expedia

Feb 2017, Expedia 4Q earnings, 2017 guidance 

Mid 2017, Expedia IPO's Trivago, highlights a valuation discrepancy for the core OTA business