Priceline: Discounted Cash Flow Analysis

  • Discounted cash flow analysis uses future free cash flow projections and discounts them to arrive at present value of a company.
  • Priceline has been a part of our top stocks picks and has returned 77% since its inclusion.
  • Using the DCF valuation method, we see a 25% potential upside in Priceline stock.

Three straight years of crushing analyst estimates of earnings has catapulted Priceline (PCLN) stock from a price of $469 to its current price of $1343.4, a 42% annualized gain over the last three years. Priceline, which stands out among OTA’s (Online Travel Agents) for its highly profitable business model, crossed the $1000 price mark at what are reasonable valuation multiples. Priceline stock, which has been among our top stock picks for over 10 months now, has surged 77% since its inclusion into our top stock picks.

While DCF (Discounted Cash flows) model is not usually a preferred model to value an internet company, considering the operating efficiency of Priceline’s business model, we evaluate the firm using the classical test of DCF valuation. Our latest valuation reconfirms our current opinion on Priceline: there is significant upside for this fundamentally strong company, with international expansion through booking.com and agoda.com fueling growth at the company over the coming years. Our latest analysis of the company sees the current price as attractive with a significant potential upside over the coming months.

Priceline Valuation: Forecasted Growth and Free Cash Flows

We update our Priceline valuation using a DCF (Discounted Cash flow) model, wherein we have projected the financials up to 2018 and used a growing perpetual cash flow beyond 2018. The table below gives our estimates of key parameters used in Priceline valuation.

Year 2014E 2015E 2016E 2017E 2018E
Revenue growth (as %) 24.6 22.0 18.5 14.3 9.8
Operating margins (as %) 25.0 27.0 29.0 31.0 33.0
Capex (as % of revenue) 1.5 1.6 1.6 1.5 1.2

Our revenue estimates and profitability estimates are influenced by the segmental growth rates and also management guidance for those segments. We expect the profit margins to temporarily take a dip from the current levels of 35% operating margin, a result of the management’s current investment initiatives to sustain growth at the firm. We see an increase in Capital expenditures (Cap-ex) over next three years before they fall back to current levels over 2017-2018.

Our revenue estimate is based on the growth rates of the three segments; Agency revenues, Merchant revenues and other revenues (consisting mainly of Kayak.com revenue). The expansion of booking.com into USA and Australia and higher revenues from Asia through growth of agoda.com are key factors which will drive growth at the firm, apart from traction in revenues from kayak.com.

Using the various parameter estimates as mentioned in the above table, we estimated the free cash flow (FCF) to Priceline in each of the next five years and a steady state FCF beyond 2018. Our estimates of FCF are given in the table below.

Year Estimated Free Cash Flow (FCF)
2013 $2.285B (actual)
2014 $2.124B
2015 $2.725B
2016 $3.448B
2017 $4.195B
2018 $4.927B
Steady State $5.510B

Having arrived at our FCF estimates as given in the table above, we calculated the terminal value using the steady state FCF and steady state FCF growth of 3%. The next step to take the valuation ahead was the computation of the WACC (Weighted average cost of capital).

Priceline WACC calculation

Priceline's weighted average cost of capital was calculated using the firm’s current bond rating by S&P and risk free rate on 20 year US treasury bonds. Our estimated WACC for Priceline was 8.2%, which was used to discount the above mentioned cash flows. The table below gives our calculation of the WACC.

Debt cost
Weight of debt 21.4%
Cost of debt 5.44%
After tax cost of debt 4.48%
Equity cost
Weight of equity 78.6%
Beta 1.66
Risk free rate (Rf) 3.36%
Market risk premium (Rm -Rf) 6.88%
Cost of equity 9.21%
Weighted Average Cost of Capital (WACC) 8.19%

Priceline Valuation

Using the WACC, the steady state FCF and growth in FCF at perpetuity stage (3%), we estimated the terminal value at the end of year 2018 at $106 billion. The computation of the terminal value completed our input requirements to value Priceline. The three inputs of Future estimated FCF’s, WACC and terminal value was used to arrive at the intrinsic value of Priceline by discounting the FCF’s and terminal value by the WACC.

Our intrinsic value estimate of Priceline equity was $89.55 billion after adjusting for the debt and cash balances at the end of Q4 2013. The total number of shares of 53.3 million was taken in line with management estimates as stated in Q4 2013 conference call. The table below sums up our Priceline valuation using the DCF approach, and calculates the stock's intrinsic value.

Intrinsic Value (in thousands) $89,554,872.41
Number of shares (in thousands) 53300
Value per share $1,680.20
Current market price $1,343.44
Upside potential 25%

Priceline Target Price

In-line with our latest analysis, we update our Priceline target price to $1680, representing a 25% gain over the last traded price (as on March 10, 2014). The recent pullback in price represents a good opportunity for the long term investor to buy in on what we view as an attractive investment considering the fundamentals which support PCLN stock.

Priceline stock chart
Source: Priceline stock chart by Amigobulls

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To see Priceline’s latest stock price movement, click here Priceline (PCLN)

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Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. The author may not be a certified/registered investment advisor, and the opinions expressed should not be treated as investment advice. Buying and selling of securities carries the risk of monetary losses. Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions. Neither Amigobulls, nor the author have any business relationship with any of the companies covered in this post.

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Comments on this article and PCLN stock

santosh.reddy345
Does the profit margin fall by 10% in 2014??
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Amigobulls
In view of increased investment on account of expansion at booking.com and agoda.com, We view the margin to be hit at the operating level. While our estimate of 25% operating margin is a conservative estimate, We prefer to be wrong the conservative side rather than being wrong on the aggressive side.
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