http://www.businessweek.com/stories/2002-06-13/the-bid-that-could-ground-expedia

Markets & Finance

The Bid That Could Ground Expedia


By Scott Kessler Making money in stocks -- particularly in Internet stocks -- has been almost unbelievably difficult (at least for buy-and-hold investors) over the past two years or so. Since closing at an all-time high on Mar. 10, 2002, the technology-laden Nasdaq was down a staggering 70% through June 11, 2002. Internet stocks fared even worse, with TheStreet.com Internet Index plummeting 92%.

Over this same time period, shares of the leading online travel-services company, Expedia, more than doubled (after adjusting for stock splits). To put it another way: Amid the dot-com crash, the economic slowdown, the September 11 terrorist attacks, and the recession, the stock of an Internet travel company sharply outperformed the S&P 500-stock index. While the country's blue-chips swooned 27% (over this time), Expedia shares surged 109%.

Expedia might not be a household name quite yet, but it's well on its way. It booked over $1.1 billion in travel business in the first quarter of 2002 and is the world's most-visited travel site (see BW Online, IT 100, "Expedia's Excellent Adventure").

CHANGE OF VIEW. At S&P, we love Expedia's fundamentals. It's experiencing high demand, gaining market share, and expanding internationally. Margins and profitability are improving nicely. Considering our long-term expectation for annual growth of 33% and notwithstanding the shares' recent runup, we believe Expedia's valuation is attractive. The stock trades at about 32 times our 2002 earnings per share estimate of $2.04, with a p-e-growth ratio of about 1.0.

So why do we rate Expedia shares 3 STARS, or hold?

Well, some of the investing public started viewing the stock differently on June 3, 2002. That's when Expedia's majority shareowner USA Interactive (USAI) -- the former USA Networks -- announced its intent to acquire the shares of Expedia that it didn't already own.

Expedia initially traded higher on the news but not because the terms were particularly compelling. USAI indicated it would offer 2.6969 of its shares in exchange for each Expedia share. At the time, this worked out to a meager 7.5% premium over the prior trading day's particularly weak close. Expedia moved higher on June 3 because USAI's indicated offer was seen as the beginning of a bidding process that would likely prove lucrative for Expedia shareholders.

HIGHER OFFER? Wall Street thought it had seen this movie before. In February, 2002, Sabre made an offer for the remainder of its majority-owned online travel-services company, Travelocity. After deeming the bid inadequate, Travelocity received a much better offer from Sabre (22% over the initial bid) in March. By early April, Travelocity was acquired by Sabre.

However, the Sabre/Travelocity situation was much different than USAI/Expedia. Sabre not only offered cash but was also very aggressive in pursuing and winning Travelocity. The same can't be said for USAI.

The day USAI announced its intention to acquire Expedia, USAI's shares fell 7% on more than twice the normal daily trading volume. USAI investors were selling the stock en masse, concerned about share dilution, uncertainty, and merger risk. The dilution worries came not only because USAI was intending to offer its stock for the remainder of Expedia it didn't already own but also because USAI was aiming to round out its majority stakes in other online service companies -- Hotels.com and Ticketmaster (formerly known as Tickermaster-Citysearch) -- at the same time and in the same way (offering USAI stock at a 7.5% premium to the close of the two stocks on May 31.).

INSULTING. USAI responded by issuing a press release and convening a conference call in which it stated that it: 1) would not increase its offer for Expedia (and the other companies) and 2) was in no rush to complete the contemplated transactions.

Translation: USAI wouldn't sweeten its bid for Expedia.

When I learned of USAI's initial offer, my first reaction was that it was almost insulting. It had to be just an initial bid to start negotiations. Just a week earlier, shares of Expedia traded at 13% above the value of USAI's offer ($72.50 a share). In fact, in April a sell-side firm published a price target of $100.

Regardless, Expedia traded well above USAI's bid price, which I considered as a floor that would support Expedia's shares. Upside from an increased offer or favorable news on fundamentals seemed quite likely.

NO OFFER YET. But USAI threw a wet blanket on things. It wouldn't up its intended offer for Expedia. Heck, according to USAI's Chairman and CEO Barry Diller, Expedia should be thankful for any premium, let alone one that was once 7.5%. And USAI is going to take its sweet time to initiate an exchange offer for Expedia shares. You see, USAI has yet to formally make the offer. At the Bear Stearns Technology Conference on June 12, an Expedia executive said the company hadn't received a firm offer and was going proceed accordingly.

So far, Expedia has convened an independent committee of directors to evaluate the situation. But for more than a week after USAI expressed its initial intent to acquire Expedia, we still haven't heard anything about what the company thinks.

Does it believe that the proposed exchange offer is inadequate? Does Expedia expect to get a deal done? All we know is that USAI believes its offer sufficiently values Expedia, and that since this is the only opinion of the stock that has been publicly shared by the parties, many observers believe that USAI may be right.

MOVING IN SYNC. What does this mean for Expedia's shareholders? Well, the situation led me to downgrade the stock from accumulate (4 STARS) to hold (3 STARS). It appears that Expedia's silence and inaction (and implied perception of agreement with USAI's value assessment) have resulted in the expected USAI offer almost restraining the upside on the shares. My impression is that regardless of whatever positive news emerges about Expedia's business, the shares will largely trade in sync with USAI.

It appears to me that either way, unless Expedia's directors make a strong and convincing argument that the intended USAI offer is inadequate (and the likelihood of this is becoming increasingly small), Expedia shareholders lose in the near term. Expedia shares will trade along with those of USAI. If USAI moves forward and executes an exchange offer for Expedia shares, USAI's stock will fall on concerns regarding dilution and merger risk. If USAI stands pat, the stocks will be mired in uncertainty about the proposed transactions.

Barry Diller has proven himself to be quite effective when it comes to negotiations over the years (even when he lost out on acquiring Lycos several years ago, it was fortuitous). He has made big bets in e-commerce, and many of these, including the one he already placed on Expedia, have paid off handsomely.

But in this situation, he clearly is doing what he believes is best for USAI's shareholders, not for Expedia's. And that's well worth noting, because he sits on Expedia's board of directors. Analyst Kessler follows Internet software and services stocks for Standard & Poor's


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