During our third quarter portfolio update, we profiled portfolio holding, Booking (BKNG). Below is a replay of our live commentary on the company from our quarterly portfolio update webinar and an excerpt from our QUARTERLY LETTER.

Booking

On the March 20, 2020 conference call we referenced at the beginning of this letter, we discussed our assessment of online travel agent Booking Holdings during the initial phase of the pandemic. At that time, we explained why we continued to hold a position in the company. We highlighted that while we fully expected demand to collapse and be slow to recover, our analysis indicated that they were very well positioned to survive the pandemic even if it lasted much longer than expected. And we said that companies that survived the pandemic would be well positioned to thrive on the other side

The key for us to holding the stock was our belief that traveling is hardwired into human DNA. While we could not know how long the pandemic would last, we were certain that when it was once again safe to travel, business would boom once again.

Today, more than 18 months later, travel has come roaring back despite the pandemic still not having come to an end. There continues to be significant barriers to travel, such as severe restrictions on international travel and the general health concerns of travelers. But in areas where people are allowed to travel, such as domestically within the United States, leisure travel has boomed.

During the first two weeks of July, which included the 4th of July holiday and occurred during a low point of COVID case counts prior to the rise of the Delta variant wave, total US hotel occupancy was down less than 5% vs the same period in 2019, while prices for hotel rooms were actually up. This strong recovery occurred despite business travel still being extremely depressed.

US domestic hotel performance shows us how humans will behave when they perceive COVID risk to be low and they are not legally restricted from traveling. But the majority of Booking’s business is in Europe, where travel patterns have yet to recover to the extent seen in the US due to a weaker economic recovery, a slower rollout of vaccines, and intra Europe travel restrictions. So, much of the company’s recovery is still to come.

For the full second quarter of this year, which began in April while vaccine rollouts were still ongoing, Booking’s total global hotel nights booked were still down 26% vs the same quarter in 2019. We don’t expect that Booking will report hotel reservations that exceed 2019 levels until sometime next year. But by the summer of 2022, after missing two years of summer vacations and international travel considered safe once again, we believe that Booking’s business will be back and continue to grow significantly for years to come.

But even if travel does return to pre-COVID trends, why will Booking thrive in in the post-COVID world?

It is true that business travel may be permanently lower after COVID as two years of Zoom calls has made some businesses realize they simply don’t need to spend as much money flying employees around the globe. But importantly Booking is highly focused on the leisure travel market and there are no indications at all that COVID has permanently impaired people’s desire to travel the globe on vacation.

It is true that alternative accommodations such as those offered by Airbnb will likely continue to grow faster than hotel bookings. Airbnb, which is the leader in this market, has reported that their own number of new bookings in the second quarter of this year was down less than 1% vs the same quarter in 2019. But this is partially due to Airbnb’s greater exposure to the US vs Europe relative to Bookings. This is an important category of lodging that better meets some leisure travelers needs than a hotel room. However, during the pandemic, travelers have very rationally placed a high priority on limiting their exposure to other people. This made alternative accommodations much more desirable relative to hotels, but for a reason that we do not believe will persist as the world becomes more fully vaccinated and the risks of COVID recede.

Importantly, Booking has built their own robust alternative accommodation business that made up over 20% of total room nights booked prior to COVID and which has been averaging close to 30% of room nights during the pandemic as the drivers of Airbnb’s strong results also support Booking’s business in this area.

As we’ve said in the past, we admire Airbnb’s business, and we would consider investing in the company at the right price. We are confident that Airbnb and Booking can both win. But in the near term, we have not yet gotten comfortable that Airbnb’s long-term plan to go from a barely profitable business to generating fantastic levels of profitability is entirely credible. While they were still running significant losses in 2019 on $4.8 billion in revenue, when Booking was at the same level of revenue about a decade ago, they were already reporting profit margins at the levels that Airbnb says they’ll get to someday.

So, the primary competitive concern for Booking Holdings is whether or not leisure travelers may start to book more of their hotel reservations via a competing third party or by being more likely to book directly with hotels. Honestly, we are just not concerned about other online travel agents. There is nothing particularly new that they are doing that would change the competitive dynamics with Booking. While there are some newer OTAs seeing surges in popularity, that has regularly been the case in the past as well and is just part of the normal competitive industry dynamics. But what we do monitor closely is the Google Hotels search product.

Ensemble Capital discussed Google Hotels in a blog post titled Who’s Scared of Google? Not Booking Holdings, in December of 2019 just a few months prior to COVID. Our contention at the time was that while the Google Hotels search product was very bad news for online travel companies that depended on free organic search results to drive traffic to their sites, Booking Holdings had built their business around paid Google ads. While we said we were monitoring Google Hotels closely, we did not see it having a material negative impact on their business.

So far, our contention appears to have played out as we expected. According to research by Bernstein, 83% of all clicks and 89% of sales inside of Google Hotels are made via paid rather than free listings. And the conversion rate, or the frequency with which a traveler who clicks on a hotel listing completes a reservation, is 65% higher for paid listings.

In addition, Booking focuses on working with independent hotels, rather than the major brands. While the major brands are advertising heavily within Google Hotels, just as they advertise heavily elsewhere, independent hotels in the US are 67% less likely to advertise inside of Google Hotels than their big brand competitors. And in Europe, where independent hotels make up much more of the market than in the big brand dominated US market, only a third of all hotel listings include a direct booking option in Google Hotels.

The simplistic narrative about Booking Holdings is that they are nothing more than a logistical service provider that helps connect travelers with hotels. If this were the case, then Google as well as many other service providers could easily compete. But Booking Holdings doesn’t sell internet traffic. They provide hotels with booked guests. Getting guests to book a room at your hotel is not just a logistical problem, it is a marketing problem, and one that Booking is widely regarded as the very best in the business at solving.

While big, branded hotels employ their own team of top-notch marketers, this simply isn’t possible for small, independent hotels and chains. So, the existence of Google Hotels as one more place for a hotel to place an ad does not fundamentally change the fact that getting people to book hotel rooms is challenging. Less than 5% of the time that someone clicks on a paid hotel ad in Google Hotels do they actually complete a reservation. It is clear that placing an ad and getting a traveler to click over to your website is only a small part of the problem that hotels need to solve. This is why hotels only having to pay Booking for a confirmed reservation makes their value proposition so attractive.

While the fact that the US hotel market is much more dominated by large chains than Europe tempers the degree to which we think Booking can expand in the US, there is no doubt that they are using the massive disruption of COVID and their own very healthy financial status to launch a major strategic initiative in the US. In 2020, Booking.com ads for US hotels in Google Hotels were the top listing only 29% of the time, in second place behind Expedia owned Hotels.com. But in 2021, Booking.com ads are showing up in the top listing an incredible 72% of the time, with Hotels.com plummeting to winning the top spot only 18% of the time.

There is no doubt in our mind that humanity’s long-term interest in leisure travel has been unaffected by COVID. It is too core to the human experience to be disrupted by a couple years of a health crisis. We believe the company remains the most important source of business for independent hotels and will remain so for a very long time. They have been in a highly cooperative relationship with Google for many years, illustrated by the fact that Booking is thought to be one of Google’s very largest advertising customers.

Until COVID is firmly behind us, we expect continued volatility in Bookings results. But questions about them surviving the pandemic are now firmly in the past, as we expected they would be even during the first weeks of the global COVID outbreak.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

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