Trip.com Begins to Aggressively Ramp International Revenue As It Explores New Growth Drivers

Senior Equity Analyst

Kai Wang

Narrow-moat Trip.com competes in China’s crowded online travel agent, or OTA, industry by leveraging the largest selection of both domestic and international hotels in China on its platform and relying on user stickiness as a one-stop shop for travel ticketing, accommodations, and packaged tours. The platform is now also generating revenue from advertisement in which it hopes to take 3%-5% of the ad market, but nearly all its revenue streams are travel-related, and coronavirus lockdowns in China has cratered demand due to the inability to travel or unwillingness to quarantine.

After better-than-expected pent-up demand after China's reopening, we believe that both international and domestic revenue should see recovery close to, if not greater than, 2019 levels. The company believes it can reach long-term non-GAAP operating margins of 20%-30% on the back of its international, outbound, and high-star hotel businesses given their higher monetization rates, but the lack of demand has affected these businesses, and total international revenue has declined to less than 5% of the mix and caused operating margin to be negative. Prior to the pandemic in 2019, international revenue were 25% of the mix and non-GAAP operating margins were 19%. We believe that reaching its long-term margin will rely heavily on the recovery, but the pandemic has been a significant headwind and has delayed its progress. We think that outbound international travel should eventually recover but visibility is still limited, there is possibility that the company could fall short of its long-term outlook.

The other key business that will drive margins is its high-star domestic hotels which generates the highest take-rate on its platform at 9%-10%. Trip.com charges low rates for its budget hotels to attract new users and directs them to its high-star hotels for future bookings as its traffic acquisition strategy, where it hopes to retain users through its wide selection of hotel, ticketing, and packaged tour options. Currently, this business has already recovered to beyond 2019 levels, and thus we believe that the imminent key catalyst for Trip.com will be its international business.

Business Strategy & Outlook

We assign a narrow moat rating to Trip.com due to its strong network effect in China’s online travel agent, or OTA, industry. The network effect for Trip.com is its massive number of hotels on the platform relative to its competitors which drives consumers toward its platform as a one-stop shop for traveling needs. Per consulting firm Analysys, Trip.com was the largest OTA platform worldwide from 2018-2020 and the largest in China for the last 10 years in terms of gross transaction value. The platform provides the widest hotel accommodation options in China with 1.4 million hotels listed compared with its closest competitors Meituan at 360,000 and Fliggy at 200,000 hotels, as of 2019. The strength of its network effect has been evident during the pandemic. While COVID-19 has decimated the OTA industry, Trip.com has been able to outperform the OTA industry as accommodation bookings and air tickets have outperformed the domestic average by 15%-20% and 5%-10%, respectively. We believe the outperformance is due to its massive hotel options and network effect relative to its competitors which would take time to replicate. Accommodations, combined with transportation ticketing business accounts for 77% of Trip.com’s revenue in 2019.

In terms of total revenue, Trip.com dominates its competitors as 2019 (prepandemic) revenue were CNY 35.7 billion compared with its closest competitor, Meituan’s hotel and in-store business, at CNY 22.3 billion and Tongcheng Travel CNY 7.3 billion. Trip.com’s revenue and high market share compared with its peers is reflective on its hotel coverage and network effect. Furthermore, its market share is bolstered by 43% and 21.84% ownership in competitors Qunar and Tongcheng, respectively. We estimate that Trip.com has just under 50% GMV market share for accommodation reservation bookings on its platform in China, and if combined with Qunar and Tongcheng, its market share increases to 65%-70% in 2019.

Despite many competitors in the industry, acquisition channels and demographics are different for each platform which also contributes Trip.com’s business moat. Trip.com’s strategy is fundamentally different from other competitors as low-star hotels are viewed as traffic acquisition channels on Trip.com’s platform for its high-star hotels where monetization and margins are higher. We believe that this contributes to its network effect where consumers view Trip.com as the platform for high quality travel accommodations and a one-stop shop in the long term. The market for low-star hotels is highly competitive and while other platforms are looking to make profit, Trip.com hopes to only break even so that it can drive traffic toward its high-star offerings according to management.

Trip.com’s dominance with high-star hotels appears to be paying off. While Meituan indicated that it has become the leader in the hotel booking industry in terms of the number of rooms booked and implied that it has taken market share, we believe that Meituan’s metric is based on low-star hotels and hourly rooms where monetization rate is much lower than that at Trip.com. We estimate that Trip.com has 50%-plus the market share for high-star hotels where the take rate is 9-10% compared with 5%-6% for low-star hotels. As a result, we estimate that Trip.com’s room nights booked were about 300-320 million compared with Meituan’s 392.4, but domestic accommodation revenue were CNY 10.5 billion versus Meituan’s CNY 5.5 billion estimate in 2019 despite having more room nights booked.

In addition, the average daily rate, or ADR, for both low-star and high-star hotels is different for Trip.com and Meituan based on how each company classifies their listings. For both classifications, ADR is higher for Trip.com than Meituan as high-star and low-star is CNY 600 and under CNY 300, respectively, for Trip.com – compared with slightly above CNY 200 and CNY 150, respectively, for Meituan. This would imply that hotels on Trip.com’s platform are skewed toward the higher end and implying that market share for high-star hotels is even higher. Furthermore, the higher ADR and monetization rate contribute to a higher commission per transaction which contribute to Trip.com’s market share. Given that customers are using Trip.com’s platform to book higher-star hotels relative to its competitors, we believe that Trip.com has branded itself as the platform for better quality offerings that takes up the mindshare of Chinese consumers.

Implications on how consumers view Trip.com’s platform can also be seen through its transportation ticketing business. The transportation business, excluding Skyscanner and international flights, is essentially domestic airlines and ground transportation (that is high-speed rail, trains, buses) that is accessible to other OTA platforms and identical substitutes. Government regulations prevent OTAs from taking a commission from state-owned enterprise ground transportation, and for domestic airline ticketing only fixed booking fees of CNY 5-CNY 10 are allowed after the industry revamped the amount of commission allotted for OTAs, which implies that revenue become directly correlated with transaction volume. In 2019, domestic transportation ticketing revenue for Trip.com was CNY 8.1 billion in 2019 compared with CNY 4.5 billion for Tongcheng. Given identical substitutes and difference in revenue, we believe that this is illustrative of the mindshare and popularity of Trip.com as a platform relative to competitors who can offer the same service.

We assign Trip.com as a narrow moat, rather than wide, as ROIC has been declining in recent years due to lower take rates and increasing competition from direct channels and relatively low barrier to entry. Since late 2015, larger airlines in China have decided to increase their direct sales portions and lower the commissions to online travel agents. By 2017, the three largest Chinese airlines had reduced commission to agencies by 50% after two years, and now according to management, the platforms are only taking CNY 5 per transaction for booking fees. The airlines are also expanding to accommodation-reservation services, with the goal of cross-selling with air tickets. Despite greater options in hotel selection and international flights, there are no patents nor nonreplicable barriers to Trip.com’s success, albeit that it will take time and resources to forge the same relationships and network effect Fliggy remains an Alibaba service and Tongcheng is partially backed by Tencent as well which means that other existing peers have the resources.

Trip.com has also taken active steps to enhance its network internationally. It acquired Skyscanner on November 2016 for GBP 1.4 billion which searches international travel options and compares prices. In April 2019, Ctrip announced it will issue new shares to Naspers for its 42.5% stake in MakeMyTrip, India’s largest online travel company, bringing Ctrip’s stake in MakeMyTrip to 49%. In addition, Ctrip has access to more international hotels through its partnership with Booking.com, which holds 5% of Trip.com

The major competition is from Meituan, Tongcheng, Fliggy, Tuniu, and Mafengwo, which are still much smaller in size. There is potential that Trip.com lose market share in the long term given that smaller companies will likely grow faster but its greater high-star hotel and international options, which have higher margins and monetization rate, should retain customers for Trip.com and increase ROIC again once COVID-19 wanes.

We can also look to the U.S. OTA industry as an example how certain companies have been able to ward off competitors. The network effects for Booking Holdings, Airbnb, and Expedia are driven by the large amount of travel supply content on their platforms that incentivizes travelers to visit and book. As these platforms get more visitors it motivates suppliers to list more content, and as more content is available it drives more use. This traffic allows these operators to improve the user experience quicker than smaller peers, which also improves the network and is tough to replicate. The supplier relationships also require sales and servicing, which is another hurdle to replicating, as is the scaling of supply content. We believe that given Trip.com’s scale and size, it is better positioned to maintain these relationships with its suppliers as well. 

Until 2013, Trip.com’s return on invested capital was historically much higher than its weighted average cost of capital. Due to heavy competition with Qunar and eLong in 2014 and 2015, Trip.com’s margins declined significantly, and ROIC decreased from over 80% to negative 2.8% in 2014 and 1.9% in 2015. As the company started to consolidate Qunar, which was loss-making, and increase its investment in customer services (new call centers, easier cancelation policies), its ROIC became lower than WACC. We forecast that ROIC surpasses WACC by 2024 as COVID-19 situation improves and as its higher-margin international businesses recovers.

As per Sustainalytics, a Morningstar company that provides sustainability research, the highest environmental, social, and governance, or ESG, risk is corporate governance for Trip.com. We have not seen any indication that an adverse material corporate governance event is likely to occur and that this will impact the company's moat source of network effect. 

However, there was an incident prior where the risk may come from the value-added services scandal in late 2017-2018 when consumers complained about hidden charges where the company bundled services such as insurance and other extras with airfares and other bookings on the platform. Only when confronted by regulators when they banned these “value-added services” did Trip.com (Ctrip then) stop such practices. There was also another incident where footage surfaced online of infants getting abused and fed wasabi at a childcare center for employees. Though the center was run by a third-party, video of the abuse caused backlash among the public and netizens. Management blamed these incidents for revenue shortfall where it grew only 9%-11% and short of expectations of 16%. Given prior questionable behavior from management, another incident could prompt further outrage or regulatory clampdown.

Narrow

Economic Moat

Trip.com

Trip.com Group Ltd. engages in the provision of travel-related services. It provides hotel accommodations, airline tickets, packaged tours, corporate travel management services, property management systems and advertising services. The company was founded by Jian Zhang Liang, Min Fan, Nan Peng Shen and Qi Ji in June 1999 and is headquartered in Shanghai, China.

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