Markets & Finance

USAI: A Net Powerhouse Revs Up


By Scott Kessler Standard & Poor's believes that USA Interactive (USAI) is uniquely positioned to capitalize both on the promise of the Internet -- and an anticipated rebound in discretionary spending resulting from easing geopolitical tensions and improvements in the global economy. USAI carries our highest investment recommendation of 5 STARS (buy).

And it's not just favorable technological and economic trends that make us bullish on USAI. We also anticipate that other events could benefit the stock. For example, the sale of Vivendi's (V) entertainment assets, in which USAI has a financial interest akin to a debt holding, could happen within weeks and would likely alleviate perceived uncertainty associated with this relationship.

We would note that USAI's investment is secured by these profitable assets, and we're not concerned about its financial viability. We expect that over the next several months, USAI could prevail in a lawsuit alleging that Vivendi has not paid it some $620 million in owed tax liabilities.

CLEARER PICTURE. We also believe that USAI and its shares will be benefit from completing the purchase of the stakes in publicly held subsidiaries Expedia (EXPE) and Hotels.com (ROOM) that USAI doesn't already own. That's expected to be done by mid-summer. Once these transactions are closed, USAI's complexity and the perception of it as a holding company (which have somewhat hampered its shares' performance, in our opinion) will be addressed to a large extent. USAI has already starting to work more closely with Expedia and Hotels.com to achieve revenue and cost synergies.

Lastly, we believe that by yearend, USAI will show its intentions for the over $4 billion in net cash on its balance sheet. It could make additional acquisitions, invest in its existing businesses, or repurchase stock. We expect it to do all three. Indeed, on May 5, USAI announced that it struck a deal to acquire online-mortgage provider LendingTree.com in a stock deal valued at $734 million.

Through various operating units and subsidiaries, USAI has a leading market share in several important categories of interactive commerce, including travel (Expedia and Hotels.com), tickets (Ticketmaster), and personals (Match.com). USAI's Home Shopping Network (HSN) is No. 2 in terms of gross merchandise sales in the home-shopping market.

PRICING POWER. This expansive e-commerce network and significant market positions provide the potential for USAI to become an integrated marketing and selling giant -- the first of its kind on the Internet. Already, Ticketmaster offerings are made available to Expedia users planning a trip, and USAI's Entertainment Book publication directs holders of its coupons to discounts at Hotels.com.

One of the last remaining Internet bellwethers, USAI also has notable pricing power. That bodes well, as industry research firm International Data Corp. (IDC) forecasts that consumer e-commerce spending worldwide will increase at a compounded annual rate of over 40% through 2006.

We believe that USAI should benefit from increases in both the number of Internet users and rates of usage. IDC has projected that the Net's global population will grow from 597.3 million in 2002 to over 1.5 billion by 2006. Over this period, IDC expects those buying goods and services online to increase at a compounded annual rate of 24%. Consumer Internet spending is expected to nearly quadruple during this time.

SWEET SPOTS. USAI's network of leading Internet businesses (which also includes well-known sites Citysearch and Evite) garners significant online traffic. According to Nielsen/NetRatings, as of the week ended Apr. 27, USAI reached about 8% of all Internet users.

S&P believes that travel is the Internet's largest consumer category, and we project that travel services will account for over 40% of USAI's 2003 revenue. According to PhoCusWright, a Net travel research firm, in 2002 this segment accounted for revenues of over $29 billion, an annual increase of 47%, while overall travel-industry sales fell 5% in 2002. We project that online travel revenues will increase 28% annually over the next several years.

Event ticketing is another large consumer e-commerce market, and USAI's Ticketmaster is the leading U.S. provider of automated ticket services. This site accounted for 47.4% of the total tickets USAI sold in the first quarter of 2003. Gross merchandise sales in the entire online ticketing category climbed 45% in 2002, according to comScore, a information provider and consultancy focused on Internet consumer activity. Ticketmaster accounted for 14% of USAI's revenue for the first quarter of 2003. S&P forecasts that growth in this online

category will average 35% over the next three to five years.

ON TV TOO. According to the Online Publishers Assn. and comScore, the personals/dating category became the Internet's largest paid-content segment in 2002, with $302 million in revenues, up nearly three-fold from 2001. USAI's Match.com was the second-leading site by content revenue, and it had 766,000 paid subscriptions as of March, 2003, up 45% from the prior year.

In April, 2003, USAI acquired uDate.com (which has a few hundred-thousand paying users), a British-based online dating site, for approximately $141.1 million in stock. S&P projects compounded annual revenue growth for this category of 34% through 2008. USAI's 2003 budget indicates that personals should account for around 3% of revenue.

USAI also has a significant presence in another medium: TV. Home Shopping Network sells consumer goods and services by means of live customer-interactive electronic retail sales programs that are transmitted via satellite to cable TV and satellite-dish systems. As of December, 2002, HSN reached 78.8 million households in the U.S., with roughly 4.5 million active buyers. USAI also owns or has interests in several international shopping channels (in Germany, China, and Japan) that were available in an aggregate of 122.9 million households as of yearend 2002.

OUTPACING FORECASTS. USAI reported excellent first-quarter results, reflecting strength at Expedia and Hotels.com, and its wholly owned HSN International and Ticketmaster businesses. Revenues rose 38%, outpacing our forecasts, despite the negative impact of the Iraq war, which we estimate restrained revenues by as much as 2% to 3% for each of Expedia, HSN, and Hotels.com. EBITA (earnings before interest, taxes, and amortization) margins widened to 12.4% from 7.8% on as USAI garners a larger percentage of revenues from higher-margin businesses, and from increases in scale, leverage, and efficiency.

Although we expect quarterly revenues for the rest of 2003 to moderate from the first quarter's level, S&P projects 31% sales growth for the year, reflecting expected strength from USAI's travel services segment (39% of first quarter revenues), offset somewhat by slower growth from its electronic retailing businesses (38%).

The 2003 first quarter marked the first time that travel services was USAI's most significant contributor to revenue. And it's now is moving to expand its presence in that segment with the Expedia and Hotels.com transactions. Consolidating Expedia into its financial statements is expected to be dilute USAI's adjusted earnings per share by 3 cents in 2003, while the effect of Hotels.com should be neutral to earnings.

HIGHER FORECASTS. Accounting for these transactions, we project adjusted 2003 EPS (excluding various costs related the Expedia and Hotels.com transactions) of 81 cents. We raised this forecast by 5 cents after USAI's first-quarter conference call in May, 2003. We also increased our adjusted 2004 EPS estimate by 3 cents, to $1.01.

Over the next three to five years, we project that USAI's earnings will grow 25% annually, reflecting significant opportunities in many of its important categories, such as travel, tickets, and personals. We also expect USAI to continue to make acquisitions, adding businesses that complement its current operations. It has suggested that it may look outside its core operating segments for takeover candidates, such as LendingTree.com.

On a Standard & Poor's Core Earnings basis, our EPS estimate for 2003 is 10 cents. This reflects an estimated $196.4 million in stock-option expenses under accounting regulation SFAS 123. We expect the impact of stock options to decline after 2003, when USAI will be acquiring both Expedia and Hotels.com. USAI has no pension-related expenses, as it doesn't maintain a defined-benefit plan.

UNDERVALUED? We believe that USAI is best valued using

discounted cash-flow analysis. Our intrinsic value estimate is about $44 per share, which signals notable appreciation despite some conservative assumptions (e.g., a

Beta for the shares of 1.5 and a free cash-flow growth rate of 3% in future years). As of the close of trading on May 1, the shares were trading at a 36% discount to our intrinsic value calculation.

USAI trades at 40.3 times our 2003 adjusted EPS estimate of 81 cents. This was below the price-earnings ratio of the S&P 500 Internet & Catalog industry of 57.9. Employing our projected 25% growth rate, the stock garners a PEG (p-e/growth-rate ratio) multiple of 1.6, which was above its industry peers. However, the shares trade at a discount to the S&P 500 Internet Software & Services industry, which had a recent p-e of 66 and PEG of 2.3.

The Internet & Catalog industry largely reflects eBay's valuation, and the Internet Software & Services group primarily portrays Yahoo's. The third other large-cap Internet company, Amazon.com, recently had a p-e of 61.4 and a PEG of 2.4. So, USAI is reasonably valued compared with its Internet-company peers.

NEW TAXES ONLINE? Our forecasts, of course, contain risks. USAI's revenues are largely dependent on discretionary consumer spending, which would be adversely affected by terrorism, war, or general economic downturns. Its travel businesses account for a significant percentage of revenues and EBITA, and could be harmed by industry interruptions.

Also, changing laws and regulations, and legal uncertainties involving the Internet could harm USAI's online businesses. In addition, the application of various sales, use, and other taxes under state and local law to USAI products and services sold via the Internet, TV, and phone is subject to interpretation by the applicable taxing authorities. Analyst Kessler follows Internet software and services stocks for Standard & Poor's


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