Will Google Eat TripAdvisor's Lunch?

01/20/2012 10:30 am EST

Focus: STOCKS

Michael Tian

Senior Equity Analyst and Equities Strategist, Morningstar Opportunistic Investor

Brute force and sheer size aren't always a winning combination when going after a focused, successful powerhouse, observe Stephen Ellis and Michael Tian of Morningstar StockInvestor.

One of the higher-profile spin-offs of 2011 was TripAdvisor (TRIP), which formally separated from Expedia (EXPE) in late December.

TripAdvisor is a darn interesting company. I’ll also confess that it’s one of my favorite Web sites. When I plan a vacation, 90% of the work I do originates on either TripAdvisor.com or Kayak.com (which, incidentally, is doing an IPO in 2012).

TripAdvisor is a travel information portal. You can look up hotels, restaurants, tours, activities, flights—essentially everything you need to do to plan a trip. You can also comparison price shop and click through to Web sites (such as Expedia.com or Hotels.com) to finalize your arrangements.

The best feature of the site, and the basis of its profitability, is the 50 million reviews that users have posted about attractions all over the world. These reviews are a hard-to-replicate asset and drive a virtuous cycle: More reviews drive users to the site, who in turn create more reviews. All this then drives advertising revenue.

TripAdvisor was an early mover and built a loyal following. I’ve personally found the reviews helpful, accurate, and well organized, which is the chief reason I use the site. Today, even with more competition, about 13 million reviews are being added per year, deepening the content pool.

TripAdvisor has done a very good job of monetizing its member base. Revenue is on track for $640 million this year, versus $106 million in 2006. Pro forma operating income should be about $260 million, versus only $44 million five years ago.

Nearly 80% of revenue comes from cost-per-click advertising, another 15% is from display ads. The balance comes from nascent but highly promising subscription sources, especially the new ability for vacation home owners to list their properties for rent.

Interestingly, with newly public “Web 2.0” companies fetching astronomical valuations, investors are downright tepid on TripAdvisor. With the company’s sales growing more than 30% in 2011, you are buying the stock for about 23 times 2011 earnings. If growth sharply decelerates to 20% next year, I expect the forward P/E to be about 18.

If TripAdvisor’s business isn’t about to be disrupted, this valuation is very compelling. The company is sitting at the brink of several big waves. One, travel research and booking are moving to the Web—a trend that will continue, especially in emerging markets.

Two, Internet advertising is constantly stealing share from traditional media. TripAdvisor’s audience is naturally motivated to make purchases, which makes its ad space a valuable commodity. If TripAdvisor can remain relevant, it should grow quickly for many years. This is worth much more than 18 times forward earnings.

The Google Threat
Unfortunately, the story isn’t as clean as it might appear. Local content and local advertising is one of the Holy Grails of the Internet age. Google (GOOG) knows this and has muscled in on TripAdvisor’s turf with Google Places.

When the Google effort started, it actually pulled reviews from TripAdvisor and Yelp, but it has grown robust enough that it now exclusively highlights its own content. Thus, if you Google “restaurants Chicago,” the top results will be linked to Google Maps, with most individual restaurants carrying reviews written by Google users.

In many big American cities, Google has already built a deeper pool of reviews on restaurants, attractions, and hotels than TripAdvisor, despite the multiyear head start enjoyed by the latter. If you Google something more exotic, like “hotels Siem Reap” (where Angkor Wat is located), you might still be out of luck, but I have no doubt that will gradually change.

Despite its popularity, TripAdvisor simply cannot compete on sheer volume with the billions of users Google has at its disposal. Over time, the pool of 50 million reviews that TripAdvisor painstakingly built up over the years can be largely replicated by Google or even (heaven forbid) Facebook or Apple (AAPL).

I think at some point, the sheer size and depth of the review pool will not be the defining traffic draw for Web companies. For one, there are already large and competing pools of reviews. If you were looking for restaurants in Chicago, Google, TripAdvisor, Yelp, and myriad smaller sites like Urbanspoon or even OpenTable (OPEN) can help. Down the road, metasearch engines and new players can enter the fray as well.

Like many things, reviews experience diminishing returns. For example, if Google has a restaurant with 100 written reviews, adding 300 more won’t add much to the user experience. Therefore, it’s probable that rival pools of user-generated reviews will eventually have similar content across a broad spectrum of geographies and attractions. In this world, how does anyone stand out?

I considered this question over the past couple of days, and a few things occurred to me.

Up Next: Breadth of reviews...

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Breadth of reviews: It will be important to have an adequate number of helpful reviews for a very wide variety of attractions. There is a lot of value in being able to look up just about anything, even in the most exotic locales, and get at least a few helpful pointers.

Right now, TripAdvisor arguably has a small edge in foreign locations. But over time, others will catch up.

Accurate and high-quality reviews: A cacophony of voices can drown out the most helpful ones. More insidiously, people with agendas (such as business owners) are motivated to game the system, either to make themselves look better or make the competition look worse. No review site is immune to this.

TripAdvisor polices its site pretty vigorously, but even here there’s been gaming, especially on the “things to do” tab. The likes of Google are wild, open gardens, and I’ve seen my share of nonsensical one-liners like, “It sux!!” I think TripAdvisor has a small edge here.

User interface: This sounds pretty generic. After all, a few smart programmers can copy a successful interface easily enough.

However, I don’t think we can overstress this point: User interfaces make or kill Web sites, and are surprisingly difficult to get right. Facebook, for example, dethroned MySpace in no small part thanks to its clean interface.

In this, the advantage goes to TripAdvisor, hands down. TripAdvisor is tailored to travelers, not residents. Most of its competitors are general-interest review sites, with user experiences not tuned with a traveler’s needs.

For example, I personally find it difficult to plan a trip using primarily Google. On the other hand, on TripAdvisor, I can look at and research almost everything that has to do with my vacation, from hotels to food to activities, on just a few pages. In an industry with zero switching costs, ease of use and lack of hassle are huge competitive advantages. I think it will be difficult for Google to copy the TripAdvisor user experience without alienating its core audience.

Curating content: Given any pool of underlying content, the way of presenting information to users makes a huge difference. On Yelp or Google, you basically see everything down to the kitchen sink. At the other extreme, something like Zagat gives you only the highly edited “expert” view. TripAdvisor has taken a hybrid approach.

For example, If you Google “restaurants Chicago,” you will be overwhelmed with information as thousands of red dots appear on your map. Even after you zoom in, hundreds of dots greet you. It takes a bit of work to find exactly what you need.

Look up the same subject on TripAdvisor, and you will find an orderly listing of restaurants based on user popularity, subdivided by cuisine type and price level. The user experiences are very different, and they appeal to different people for different purposes.

If I’m looking for some food in my neighborhood, I’m usually on Google for its broad selection. If I’m in a strange city and don’t want to do too much guesswork, I prefer TripAdvisor.

All this drives at my overall point: Despite the threat posed by Google (and others), I think TripAdvisor will survive and do well. This is because different review-based sites fundamentally appeal to different audiences.

The differences in specialization, the user experience, and the presentation of information are surprisingly difficult to replicate, and there is room for multiple sites to exist. If I’m right about this, TripAdvisor is a very inexpensive stock and will make investors a lot of money.

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