Online travel marketplaces:Increasingly a scale player’s game

The travel sector remains a compelling opportunity for large online marketplacesto create value by aggregating fragmented sources of travel supply (hotels, air,cars, etc.) and matching them with large pools of incremental customer demand.

Today the online travel market globally is a $610bn opportunity, representing~45% of the ~$1.4 trillion total global travel market (per PhoCusWright). Thatpenetration rate has risen steadily since the launch of the first OTAs in the mid-1990s, but significant runway for growth remains as nascent leisure travelmarkets in the emerging economies throughout Asia and Latin America expandagainst a backdrop of increasing consumer Internet usage/eCommerce.

The leading online travel marketplaces are well positioned for sustained anddefensible growth by focusing on a few key drivers, in our view:1) Consolidating a highly fragmented travel supplier landscape –particularly for international hotels. Those platforms that offer the greatestbreadth, choice, and inventory of properties provide the most value forconsumers and set the stage for textbook “network effects.”2) Driving supplier stickiness – Having easy-to-use, powerful, and mobilecentrictools for hoteliers/suppliers is one element, but perhaps moreimportant is providing suppliers with robust/global pool of incrementalcustomer demand. Competitive defensibility and pricing power for the onlinemarketplace increases as supplier reliance on this customer source grows.

3) Scale in supplier contracting, product, and marketing – Scale benefits inonline travel are increasingly accruing to those companies that can investglobally in areas such as hotel contracting, R&D/product, and advertising.

The landscape for online travel services can seem crowded, but the largestOTAs differentiate on the supply side by having direct transactional/bookingconnectivity with suppliers. On the demand side, OTA brand investmenthelps drive more direct traffic (and less reliance on indirect/paid channels,such as Google.) Competitive advertising intensity amongst the large OTAsremains elevated but is helping accelerate share gains and top-line strength.

Against this backdrop, our preferred online travel stocks are PCLN and CTRP:PCLN – has what we view as the ideal geographic and product mix amongstlarge OTAs, with low/mid-teens percent exposure to the slower-growth/supplierfriendlyUS market and negligible direct exposure to the tepid environment for airintermediaries. PCLN’s “crown jewel” asset is its Booking.com brand, whichremains optimally positioned to leverage the fragmented international hotellandscape and has a well-established brand (buoyed by ~$3bn in annual adspend), OTA-leading inventory breadth of 493k+ bookable hotels, and asupplier-friendly agency transaction model. Lastly, the stock looks reasonablyvalued at ~15x our ‘17E non-cash EPS (vs an estimated low/mid-teens percentthree-year EPS CAGR.)CTRP – is a clear leader and consolidator in China's online travel market, withmore than 90% market share. We believe Ctrip will be the main beneficiary ofstructural growth in China's travel sector. The company has innovativetechnology and rich product offerings to take advantage of the market shift frombusiness to leisure travel and expansion toward international travel. We are alsoconfident about Ctrip's ability to integrate newly acquired Qunar and eLong andreach a 31% non-GAAP operating margin in the long term with cross-sellingamong different product lines. We estimate Ctrip's earnings to grow at a 50%CAGR over FY17–20, and our US$53 target price is based on 1x PEG.