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Online Extra: Expedia's Excellent Adventure


As 2000 ended, many people wouldn't have wanted to trade problems with Richard Barton, the CEO of online travel agency Expedia. Internet stocks were tanking. Expedia (EXPE) shares trailed hotel-reservation rival Hotels.com (ROOM) and the battered tech-laden Nasdaq index.

Online travel agencies were also dreading the mid-2001 arrival of stiff, airline-backed competition from Orbitz.com, and airlines were threatening to cut commissions on ticket sales. Meanwhile, Expedia was still losing money. Things weren't awful by Internet standards: Expedia's stock, which went public in November, 1999, never went much below $8 a share after its IPO-day peak above $60. But it had no shortage of skeptics either.

Expedia has surprised them all, though, becoming the big gorilla in the Web-travel jungle -- even as the sector has emerged firmly as the most successful category of Web retailing, accounting for 11% of an estimated $220 billion market. On June 3, Barry Diller, having bought out Microsoft's controlling stake in Expedia this year, offered $76.86 a share for the remaining Expedia shares his USA Interactive (USAI) didn't own.

NOT "OUT OF LINE." Expedia gave the stock-exchange offer a chilly reception, and Diller retreated. But he says he'll try to do the deal later, along with buying the shares of Hotels.com and TicketMaster (TMCS) that USA doesn't already own.

Now, Expedia is the flavor of the moment on a dispirited Wall Street. Its shares are trading around $67 as of June 13, down from a peak of above $80 in May. Even oft-skeptical analysts such as Prudential Securities' Mark J. Rowen -- known to Web investors for early sell recommendations on Webvan (WBVN) and Amazon.com (AMZN) -- say nice things about Expedia. Despite its new, higher valuation of about 40 times 2002 earnings (based on pro forma earnings, which don't include merger, depreciation, interest, and tax-allocation expenses), "I don't think Expedia is out of line," Rowen says.

Its reversal of fortune has a little to do with the success of the online travel market, but mostly Expedia has made its own luck. The masterstroke: Barton's moves to shift away from a reliance on selling airline tickets. By buying tour-packaging company Travelscape in March, 2000, Barton led his company into the business of selling entire vacations -- including air, hotel, and other services -- at bundled prices.

MIX AND MATCH. Complementing that move to the merchant business was a campaign to reserve large blocks of hotel rooms at prenegotiated rates, letting Expedia resell rooms for a spread rather than simply collecting a reservation fee and increasing its revenue and eventually its profits.

By upgrading technology and boosting software-development spending sharply, Expedia has enhanced its ability to package tours even more, letting users quickly mix and match different travel combinations. One result: Expedia's "look-to-book ratio," or the percentage of surfers who actually buy something, has risen to 5.8% from 3.8% two years ago.

Best of all, the blended model reduces Expedia's dependence on the airlines. The big carriers tend to have a fickle attitude toward travel agents that shifts with the demand for travel -- not to mention the wildly cyclical economics of the airline industry itself. Barton says his strategy "stems from our Microsoft DNA, which says, 'Make sure you make decisions for five years from now, not five minutes from now.'"

AFTERBURNERS ON. The strategy's impact on Expedia's numbers has been striking. Revenues rose 103% in the first quarter, to $116 million, on more than $1 billion worth of travel sold. The most dramatic part of that was the fourfold increase, to $57 million, in the "merchant business."

This growth was the afterburner Expedia needed to lift it into profitability. Earnings before interest, taxes, depreciation, and amortization jumped to $34 million, from about $4 million a year earlier. Expedia says it'll make almost $140 million this year before these charges. Under formal accounting rules, it made a $5.7 million net first-quarter profit, even after a $4.6 million accounting allowance for taxes Barton says Expedia doesn't yet owe and a $10 million one-time charge for expenses related to USA Interactive's purchase of Microsoft's Expedia shares.

Think this strategy was obvious? Think again. Relative newcomer Orbitz, a feared competitor because it gets special low airfares from the five airlines that own it, has become a big player in processing airline reservations but got less than $3 million in first-quarter revenue from merchant business. It's not yet profitable, even though it sold more than half a billion dollars worth of travel in the first quarter.

CROSS-SELLING BONANZA. Travelocity.com, which was actually the early leader in Web travel, was passed by Expedia when it failed to develop its merchant business quickly enough. Travelocity has scrambled to buy packaging companies to help it catch up, and majority owner Sabre Holdings (TSG) bought the shares it didn't own in April, at a steep discount to Expedia's valuation.

Now, Expedia's one-stop vacation planning strategy is going further, thanks to its alliance with USA Interactive. In a deal announced June 4, USA products like theater tickets from TicketMaster will be available for bundling into Expedia vacations. Users of USA's CitySearch online local entertainment guides will be able to book travel to those cities on the site, using Expedia's technology. And Expedia users will see CitySearch content about their destinations, which the companies hope will spur those to look at more advertising and buy more services.

The potential for cross-selling is part of why USA Interactive wants to buy the rest of both Expedia and TicketMaster. "The sector is probably going to grow at a very big increase rate," says USA Vice-Chairman Victor Kaufman. "Right now, about 10% of all travel is online, and I wouldn't be surprised to see that grow to 30% to 50%."

JUST A HICCUP. Expedia remains a company exposed to cyclical downturns in travel. For now, those cycles are masked by the rapid shift of travel bookings to the Web -- even the near-paralysis in travel following the September 11 attacks on New York and Washington caused only a hiccup in Expedia's growth.

Barton's moves have made the company more diversified and more independent of the airlines, and made Expedia's short-term future more stable. And with the operating leverage in its model becoming clearer, Expedia may stand to rake in big profits on all that growth in coming years. By Tim Mullaney in New York


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