10 January 2017 Americas/United States Equity Research Consumer Internet 2017 Online Travel Primer Research Analysts INDUSTRY PRIMER Paul Bieber 212 325 5774 [email protected] Scale Matters—Too Early to Call OTA Stephen Ju 212 325 8662 Downfall [email protected] Vikram Kesavabhotla ■ Paul Bieber assumes coverage of Priceline, Expedia, and TripAdvisor. 212 538 8118 ■ In this report, we provide a comprehensive overview of the online travel [email protected] sector with take-aways from our proprietary consumer survey, travel and Christopher Ford 212 538 8446 hotel market size, market share analysis, 2017 performance drivers, [email protected] competitive analysis, hist. valuations, key risks, and key data for the sector. ■ Constructive on OTAs Despite Intense Competitive Landscape: Despite intense competition, diminishing ADR tailwinds, and a new entrant unlocking potentially cannibalistic supply, we have a constructive view on the online travel market in 2017. Our positive view is based on: (1) a more favorable global macro backdrop vs. 2016; 2) attractive room night unit growth (mid-teens for EXPE and low-mid-20's for PCLN); (2) consolidation and scale creating a duopoly between PCLN and EXPE, with Airbnb gaining some share; (3) reasonable valuations, especially on 2018 estimates; and (4) continued secular tailwinds with OTA inventory advantages vs. supplier sites driving share gains (i.e., OTAs have a deeper inventory/selection). ■ Market Remains Large and Fragmented: The $1.3 trillion global travel market is very large and fragmented. According to Phocuswright and our estimates, we expect the online travel sector to reach $540bn in 2017, up 8% y/y and with $38bn in 2017 incremental growth. We expect the hotel and total accommodation markets (hotel, vacation rental, and sharing economy) to reach $473bn and $612bn, respectively, in 2017. ■ PCLN and EXPE Market Shares Remain Relatively Low: We estimate PCLN and EXPE have 10.3% and 4.9% market share of room nights, which implies a very fragmented market with significant opportunity to drive additional share gains over the coming years. ■ PCLN (OP and $1,900 TP): Positive on: (1) low market share with runway for growth, (2) marketing efficiency leadership and beneficiary of new Google ad formats, (3) unparalleled scale in online travel, (4) well positioned for Asia/China growth, (5) underappreciated alternative inventory and review ecosystem, and (6) strong track record of execution and EPS upside. ■ EXPE (OP and $145 TP): Positive on: (1) sum-of-parts valuation, (2) HomeAway 2018 EBITDA opportunity, (3) attractive room night growth with potential for acceleration, (4) inventory supply catch-up opportunity, and (5) Trivago IPO providing public market valuation for attractive asset. ■ TRIP (Neutral and $51 TP): Instant book revenue headwinds, depressed hotel shopper growth, uncertainty regarding cadence of marketing spend, and review competition from Booking.com are concerns. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. 10 January 2017 Online Travel Primer—Executive Summary Despite intense competition, diminishing ADR tailwinds, and a new entrant unlocking potentially cannibalistic supply, we have a constructive view on the online travel market and Online Travel Agencies (OTAs) in 2017. Our positive view is based on: (1) a more favorable global macro backdrop vs. 2016 (see 2017 Global Outlook: A New Narrative (Not a New Normal); 2) attractive room night unit growth (mid-teens for EXPE and low- mid-20's for PCLN); (2) consolidation and scale creating a duopoly between PCLN and EXPE, with Airbnb gaining some share; (3) reasonable valuations, especially on 2018 estimates; and (4) continued secular tailwinds with OTA inventory advantages vs. supplier sites driving share gains (i.e., OTAs have a deeper inventory/selection). While we believe the online travel market is more mature than the Street perceives, we expect online secular tailwinds to continue in 2017, with healthy room night growth, OTA scale in demand generation, and the unlocking of alternative inventory opportunity (vacation rental and sharing economy) contributing to attractive growth for Priceline and Expedia. We estimate that approximately $38bn in total travel bookings and $13bn in hotel bookings will shift to the online channel in 2017. In addition, we expect alternative inventory to fuel incremental growth for the OTAs. We anticipate the online travel market will continue to evolve with the big (Priceline and Expedia) getting bigger and an emerging new entrant (Airbnb) unlocking supply and gaining some share in the alternative accommodation category, cannibalizing some hotel bookings but also opening up a new category for OTAs. We expect competitive dynamics, company-specific execution, cash deployment (acquisitions and/or share repurchases), the macro-backdrop, and Asia demand to be the primary drivers of stock performance in 2017. Finally, we believe that competition, potential ADR pressure, macro-volatility, and unforeseen events such as terrorism will likely create stock volatility and periods of multiple compression, creating opportunity for prudent stock selection. Our Key Sector Take-aways Include: Large and Fragmented Global Market: The global travel market is very large ($1.3 trillion) and fragmented, and we expect $38bn in travel bookings to shift online in 2017, with alternative inventory representing additional growth. We also expect the total hotel and accommodation markets (hotel, vacation rental and sharing economy) to reach $473bn and $612bn, respectively, in 2017. Priceline and Expedia Market Shares Remain Relatively Low: We estimate Priceline and Expedia have 10.3% and 4.9% market share of room nights, which implies a very fragmented market with significant opportunity to drive additional share gains despite an increasingly mature market. Asia Driving Most Online Dollar Growth: The Asia travel market is the largest travel market and will reach $392bn in 2017, with online travel reaching $146bn. Importantly, the Asia online travel market has much lower total penetration rates than the U.S. and Europe, so we expect the online share shift to support higher growth rates in Asia for the foreseeable future. We expect Asia online bookings to double by 2020 from $105bn in 2015, and we expect Asia online bookings to be the largest driver of incremental sector growth over the coming years. ADRs No Longer a Tailwind; Could Become a Headwind: ADRs are no longer a sector tailwind and could become a headwind, especially if hotel supply growth accelerates in 2017-18. U.S. Online Travel More Mature than the Street Perceives: The sector is more mature than investors perceive, with U.S. leisure market penetration approaching 70% in 2017 vs. investor perception of sub-50%. 2017 Online Travel Primer2 10 January 2017 Will China Outbound Travel Recover in 2017?: The China outbound market deteriorated significantly in 2016 owing to yuan depreciation, the impact of European terrorism, and anti-corruption measures by the Chinese government. The key question is whether the China outbound market rebounds in 2017-18. Airbnb Is Top of Mind with Investors: Airbnb is a new entrant unlocking new supply, some of which is cannibalistic to OTA and hotel bookings. The emergence of Airbnb over the past several years has coincided with a generally favorable macro-backdrop and within the context of a healthy hotel cycle, so the impact on OTAs has been relatively limited thus far. Looking forward, several factors could magnify the impact of Airbnb on OTAs, including (1) more mainstream consumer adoption of Airbnb; (2) a weak macro environment that results in a flood of inventory on Airbnb, causing Airbnb ADR pressure and potential hotel ADR pressure; (3) removing some of the friction from the Airbnb experience (i.e., customer service, more online booking, etc.); (4) adding more hotel-like inventory to Airbnb; and (5) Airbnb investing more in demand generation and brand marketing to raise awareness, especially in the United States. Key Sector Risks Include: FX: The Street has not adjusted sector estimates for 4Q FX volatility, so there is some risk to 1Q and 2017 estimates. Competition: The online travel sector is extremely competitive, with many companies competing to gain share of the $1.3 trillion market. In addition, the market is extremely dynamic, with business models constantly evolving and converging. We expect the emergence of Airbnb, hotels efforts to drive direct bookings on their sites, competition between Expedia and Priceline, Google's efforts to evolve its travel search results and travel offerings and TripAdvisor's efforts to drive adoption of Instant Book to affect investor sentiment in 2017. Take Rate Pressure: We expect chains to extract some value from OTAs in the U.S. when/if contracts are renewed in 2017 assuming a stable macro-backdrop, which we view as a larger risk for Expedia than for Priceline given Expedia's large chain exposure. (Priceline's hotel supply is more fragmented, and Priceline