This article is authored by MOI Global instructor Samir Mohamed, a collaborative value investor at a family office in Cyprus.
As the market capitalizations of Airbnb and Booking show, having a strong position in the online travel market pays off. By having a large inventory of accommodations and a large user base these companies benefit from strong network effects on a regional level: If you want to book an accommodation in a city you will likely want to check out the largest online travel agents for that city. This gives you most options at the lowest price.
The same is true for other travel services like flights or rental cars. If you are travelling in the US or Europe Airbnb and Booking often have the best options for accommodations. If you are travelling in Latin America though, the online travel agent with the largest and broadest inventory of service providers in many countries is a company called Despegar.
Despegar was founded in 1999 in Argentina as an online travel agent for flights. It expanded across Latin America and into accommodations and other travel services for consumers. Unlike with travel meta search engines like Trivago, Kayak or Google Flights, you can directly book flights and all other travel services with Despegar; i.e. you will not get forwarded to the website of the travel service provider for booking.
The company had sales of 524 Mio. USD in 2017 at a 13.6% EBIT margin with more than 70% of sales in Argentina and Brazil. Its share of the online travel market in Latin America in 2017 was 12.5% and increased further in 2018. It went public in September 2017 and lost more than 50% of its market capitalization since then due to its association with Latin America and its macroeconomic risks.
According to Euromonitor the Latin American travel market had a size of 99 billion USD in 2017 of which 36% was booked online compared to 56% in the US and 54% in Western Europe. Travel suppliers like airlines and hotels are more fragmented in Latin America than in the US favoring online travel agents as they help consumers to find the best offer among many suppliers. Based on search brand recognition the strongest brands in Latin America after Despegar are Booking, Trivago (a meta search engine for hotels), CVC (a strong regional player in Brazil) and Airbnb.
In addition, there are many smaller local online travel agents. This gives Despegar the opportunity to consolidate the market either through acquisitions using its strong balance sheet or by taking market share from weaker players. Current macroeconomic difficulties in Argentina and Brazil have led to a shrinking travel market in the second half of 2018 and might accelerate the consolidation of players.
The company has several strong competitive moats which can be described in a structure that Pat Dorsey introduced in his book “The little book that builds wealth…”:
1. Intangible assets: Brand – about half of user traffic is direct (comparable to Booking’s global direct traffic rate), so there are no acquisition costs via Google or Facebook for this traffic.
2. Increasing switching costs for users:
- A shift to the mobile app (35% of transactions in 3Q 2018) increases user engagement compared to web-site usage with PCs.
- Despegar offers consumers to pay via installments through a broad network of banking partners in many countries. This option was used in 55% of transactions in 2017 and is a differentiator for the company.
- A broad product offering including flights, accommodations, rental cars, bus tickets, experiences, cruises, package deals, etc. which can be booked directly with Despegar. Booking flights is not possible with Airbnb or Booking in Latin America.
- A loyalty program is scheduled to launch in 2019.
3. Network effects: As a two-sided network with the largest user base on the one side and the largest inventory of travel suppliers on the other side Despegar benefits from increasing network effects as the company is gaining market share.
4. Economies of scale:
- Volume discounts with travel suppliers, especially airlines.
- Operating leverage – almost half of operating expenses were fixed costs in 2017.
Despegar has multiple growth drivers in two categories:
1. Increasing the number of customers:
- A growing middle class in Latin America drives travel spending.
- Increasing access to credit cards enables online transactions.
- An increasing share of online travel bookings in the total travel market
- Strong moats, especially network effects, lead to further market share gains.
2. Increasing the average revenue per customer:
- The shift from PC to the mobile app increases user engagement and facilitates on-travel sales, e.g. for experiences or bus tickets.
- More user data from the mobile app allows very targeted marketing and better conversion.
- Broadening the product offering and package deals (e.g. flights and accommodations) increase the share of wallet.
- The loyalty program (from 2019) encourages repeat purchases.
Valuing the company is challenging: It is a high growth compounder that has not reached scale yet in all its businesses and short-term forecasts can be obsoleted by macroeconomic factors like the devaluation of local currencies. Looking at a 6-10-year time frame, though, it is likely that the company will reach scale and macroeconomic volatility will have less influence on longer-term business results.
In a conservative forecast assuming average historic growth in number of customers of 11.3% and no growth in revenue per customer Despegar would have an EV/EBIT ratio in 2025 of about 3 at the current share price.
Customers often pay Despegar a few months before a holiday trip while the company pays its travel service providers like hotels after the trip. This attractive cash flow cycle leads to negative capital employed; i.e. the company is effectively financed by its customers and travel suppliers. Therefore, the company does not need additional capital for future growth.
By far the biggest risk is the spread of the currency and debt crisis from Argentina to other Latin American countries, especially Brazil. In addition to the decline of local currencies the company’s business would be affected by a significant decline of consumer spending on travel. A second risk is a global recession that could increase risk aversion towards emerging markets, weaken local currencies and create problems with debt issuing for governments and companies.
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