Last week my family embarked on a road trip to beautiful Tybee Island in Georgia. We saved a lot of money booking four nights in hotels, along the route, with help from one of my personal and Strategy Lab holdings: Priceline Group.
I added Priceline to my model portfolio in December, 2012, because it represented practically everything I look for in a long-term investment, and I believe my original investment thesis still holds true. That thesis is simple: The online travel industry is disrupting old ways of booking travel, and Priceline is the most significant and profitable competitor with plenty of growth ahead.
Consider the typical family driving home to Canada from spring break down south. No longer must you drive until you get tired and hope you can find a decent hotel at a fair price. Instead, while stopped for a coffee break at a McDonald's in North Carolina, my wife and I agreed we could make it to the top of West Virginia. Using free WiFi and the Priceline app on my iPhone, we booked a beautiful hotel with a heated indoor pool for the kids. It took less than five minutes to decide, research and book our room.
The convenience of booking via a mobile device is important. As the company discussed on its latest conference call, mobile bookings have gone from a tiny slice of the action just a few years ago to nearly half of all bookings today. It tells me that once a customer picks a preferred online travel booking platform, they'll go straight to that brand's app or website from whatever device happens be most convenient. It's all about taking potential friction away from the user experience to win the business more often.
There is still a ton of growth left in the story, in my opinion. The travel market is a trillion-dollar market. Priceline and its closest competitor, Expedia, control a combined total of about 10 per cent of this industry today. Consider that Priceline Group owns much more than just priceline.com, but also booking.com and several other prominent brands around the world. Expedia owns hotels.com, Hotwire, Travelocity, and is in the process of buying Orbitz. In other words, these two companies dominate practically every major online travel brand most people have heard of.
Priceline has incredible gross margins. Out of last quarter's $1.84-billion (U.S.) in revenue, gross profit was $1.68-billion, or 91 per cent. Gross profit is up almost 26 per cent compared to the year-ago quarter. Operating margin was 28.3 per cent. Are you wondering what the company's single largest operating cost is? It's online advertising. Priceline Group spent half a billion dollars running online ads last quarter, and I'm actually happy when advertising expenses go up.
Remember, I'm a long-term thinker, not a stock trader. When I think about the big picture I see Priceline investing a ton of capital to train a growing number of users to book travel plans through their platform. This is very similar to how Amazon trains us all to know, like and trust its brand whether we are buying books, electronics or garden supplies. Amazon and Priceline are both betting that, over a number of years, consumers will prefer to buy online, and they'll choose companies that give them the best possible experience. It costs a lot of money to indoctrinate new customers into the virtues of your platform, but once that's done you might just have a customer for life.
That's why I see online advertising as an incredible investment, not a cost. Once the industry matures (and growth slows), I imagine advertising expenses, as a percentage of revenue, will drop and profitability will increase.
At a stock price of just under $1,200 today, Priceline trades at about 20 times this year's expected earnings per share. As the most profitable leader in a fast-growing and disruptive market that has years of growth ahead of it, I plan to hang onto my shares through many more years of family road trips.