Expedia Group Inc. (EXPE, Financial) had a bad third quarter. Reporting earnings on Nov. 5, the company narrowly missed analysts’ estimates. The miss was especially embarrassing, since Expedia’s new management team had previously increased their earnings guidance.
According to Expedia, the miss was due to search engine optimization headwinds. However, a look beneath the surface reveals that this clame may not account for everything.
SEO headwinds get the blame
Expedia’s management team tried to place the blame for the poor quarter entirely on the shoulders of SEO. CEO Mark Okerstrom was unequivocal on this point during the company’s earnings conference call:
“The quarter did not play out as planned...We saw incremental weakness in SEO volumes and a related shift to high-cost marketing channels.”
The company claimed that the increasing cost of SEO and marketing was to blame for the miss. As PhocusWire discussed on Nov. 6, this was a recurring theme during the call:
“Changes in recent years to Google’s algorithm has forced Expedia and other OTAs to lose organic visibility and rely on paid advertising to reach consumers. CFO Alan Pickerill says the SEO challenges can be felt ‘across multiple product categories and multiple regions’ and moving to paid links presents “a sizable headwind for us.’”
As a surface-level explanation, this makes sense. The problems they cited regarding the increasingly challenging online marketing environment are real. However, they were not solely to blame for the third quarter’s problems.
Unsatisfactory answer
Last week, Deutsche Bank released its latest research update on Expedia. Deutsche’s analysts found that SEO headwinds simply could not be blamed for Expedia’s miss:
"We believe that the old management team may have used ‘SEO headwinds’ as an excuse for broader operational issues given their sales and marketing spend was largely in line with our estimate and room nights were slightly better than we expected in the quarter. Despite management indicating that SEO headwinds increased in the quarter, S&M expense was only $25M above our estimate in 3Q while room nights for the quarter were actually slightly ahead of our estimate (+ 10.6% v DBe + 10.5%). Furthermore, if we look at direct S&M ex-trivago per room night, by our calculation, it only increased 1% Y/Y in 3Q19 which implies it decelerated on both a 1-Yr and 2-Yr stack basis. Putting this all together, we do not believe that SEO headwinds was as meaningful an issue in the quarter as investors have perceived and the valuation multiple reflects.”
In other words, Expedia says higher marketing costs were the problem. Yet, upon assessment of its financial results, cost of marketing has increased only negligibly. Thus, this cannot be the true cause of the problems. As Modest Proposal, a leading light of Twitter investing, observed on Dec. 11:
“It seems clear now that SEO was not the primary challenge Expedia had in the quarter, but was a convenient excuse."
Failure to execute
If SEO headwinds were a convenient excuse for a bad quarter, what was the real reason for the bad quarter? Modest Proposal offered an alternative answer on Dec. 11:
“Expedia's execution, and the internal reorg, was the problem. Yet the industry as a whole suffered from the perception [that] it wasn't just an idiosyncratic misstep...Having followed Expedia pretty closely for a decade, you can count on a massive execution misstep every couple years like clockwork. Q4 2010, Q2 2013, Q3/Q4 2017, Homeaway's biz model shift, and now Q3 2019.”
Moreover, Expedia continues to be weighed down by high operational costs compared to major rivals, most notably Booking Holdings Inc. (BKNG, Financial). The differential in personnel costs is staggering. In 2018, personnel costs as a percentage of revenue were 29.3% for Expedia, whereas they were just 14.1% for Booking. Deutsche Bank has surmised that this differential is due in no small part to Expedia’s tendency toward lavish internal spending, which has included the construction of a new headquarters, generous stock based compensation for executives and indulging in perks like private jets.
Verdict
Expedia is no stranger to the occasional operational failure. The latest troubles are just one in a series of cases of poor management execution.
Expedia has tried to obfuscate blame, but the reality is clear. Until the company can turn things around on a broader operational level, concerns about SEO headwinds will hold little water for serious analysts.
Disclosure: No positions.
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