TIVP047: Booking Holdings (BKNG): Does Booking.yeah = Value.yeah? w/ Shawn O’Malley & Daniel Mahncke

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26:41To begin getting smarter about investing, just visit theinvestorspodcast.com slash get started with stocks. That's theinvestorspodcast.com slash get started with stocks. And for a limited time, you can use code STOCKS15 for a 15 % discount at checkout. Well, I can't argue with the facts. And, you know, when we first looked into Airbnb, that was the first time I realized how big booking actually is. You know, when we looked at the competitors and we saw the market share data, it's pretty amazing to see how big that company actually is. And if any of the listeners here book alternative recommendations through booking.com, please let us know in the comments.

27:19We might just not see them because we spend too much time on Airbnb. That's probably true. And so, you know, just looking at Expedia and booking a little bit more, the difference between them is that booking primarily dominates in Europe, where the hotel industry is much more fragmented and has many smaller operators who do tend to rely on booking more. Not quite as much as Airbnb hosts do, but more similar to Airbnb hosts than Marriott and Hilton rely on booking. And so Expedia, on the other hand, primarily focuses on the North American market with sites like Hotels.com and Vrbo, but the North American hotel market is much less fragmented.

28:04So Expedia is working the most with these major hotel chains that have pretty substantial negotiating power in their own right. And so consequently, Expedia has generally proven to be a much worse business than booking. Booking is bigger in gross booking value terms by roughly 50%, but still they're able to generate more than six times more total operating profit. So for every dollar of travel transactions that flow through booking, booking is converting a much higher percentage of that activity into operating profit for its business compared with Expedia. And I think there are a lot of reasons for this, but I do think that the markets they dominate and the scale of the hotel chains they work with on the supply side are important factors for explaining it.

28:52And another aspect is that 90 % of Booking's business goes through booking.com, whereas Expedia has a handful of more distinct brands that offer less synergy. It's costlier to have a less centralized tech stack with a number of different teams supporting different apps and websites. I'm not as familiar with Expedia which might be because they're mostly operating in North America. So can you zoom in more on how the competitive relationship between them and booking has developed over time? Yeah, Expedia dominated the American OTA market throughout the 2000s using a model where they would collect payments from customers up front.

29:34When the company expanded into Europe, though, it struggled to gain the same popularity largely because Europeans at that time were not used to paying up front for hotel rooms. And they had really lower rates of trust in making internet payments than Americans. And so the other wrinkle here was that Expedia effectively charged 25 % commissions to hotels versus the 15 % rate that booking.com took, making Expedia just really disadvantaged as a foreign contender. You're coming in at a more expensive take rate and your business model is not compatible in the same way with the preferences of the local populations.

30:14So in other words, listing on Expedia was far less attractive for hotels since they had to pay them a bigger fee to test online sales with than with booking. And then if you have less supply listed on your platform, that also just makes your travel site a lot less useful to customers. So booking as this up and coming company was happy to earn lower commissions in Europe than Expedia's leadership team was, who were reluctant that the lower margins in Europe would dilute the overall quality of the business. And then as managers of a publicly traded company, that they would essentially be penalized for less profitable growth.

30:52And so I don't think it would be a proper episode of this show if we didn't find an excuse to bring up the innovators dilemma. but this is really as classic a case of it as any. Expedia as the world's largest online travel agent seeded its lead to booking.com by 2010 by sticking to what had worked for them in the past and by not expanding into new markets more aggressively. And so Expedia did eventually lower its margins. But by that point, booking had firmly established a dominant position within in Europe. And the outcome today is that Booking Holdings has a market capitalization in excess of five times that of Expedia.

31:32So it's really been clear who won and who made the right decisions in hindsight. But as we've said, Expedia did not lose the US though, which is important. And that's why most Americans will be more familiar with it. Expedia is still something more than three times the size of Booking Holdings in the US, while Booking is more than four times the size of Expedia in Europe. And people might be surprised to hear this, but there are big fundamental differences between the hotel industry in the US and Europe. It's not an apples to apples comparison. In the US, over two thirds of hotels belong to one of the major chains.

32:08Whereas in Europe, the dynamic is basically reversed with two thirds of hotels being independent. So the US is littered with these large 100 plus room hotels, maybe 1000 plus room hotels belonging to flagship homegrown hotel franchises such as Marriott and Hilton, who are really the two that have come to dominate this entire ecosystem. Europe, by contrast, has many, many more independent boutique hotels, typically with only maybe a dozen or a few dozen rooms apiece, which are not going to fit into a consolidation within a major franchise as well. And so for context, again, franchise hotel operators benefit from the brand and marketing prowess of their deep-seated corporate partners.

32:56So the Marriott's and Hilton's of the world. But independents, by contrast, have none of those same resources. So they get considerably more value by signing up with a large OTA like Booking since Booking has over 20 years of experience in marketing hotel inventory online that they can tap into, right? And what that means more literally is millions of cumulative A-B tests behind its ability to engineer the precise page layout, language, and booking process that will result in the maximum conversion of customers browsing their websites over time. I wasn't aware of the difference in the hotel market between Europe and the US before, but now that I've booked some hotels in the US in the last couple of months, I realized that if you just Google for a Hilton hotel, you'll probably find one in every major city that you will visit.

33:48And that just seems much easier than going through either Expedia or booking.com, which as you said, it's totally different in Europe, where you have a lot of small hotels for which it makes a lot of sense to be listed on a site like that. And I don't know, it sounds like Expedia really shot themselves in the foot with their expansion strategy. I'm pretty sure we can count on Airbnb not making the same mistakes. If anything, Airbnb has learned that lesson by trying to make its platform as attractive as possible to hosts on the supply side of the network, which is very important because you need the supply to even get a chance to get the demand.

34:19One of the other things that we love about Airbnb is that their brand is so strong. They're able to spend much less on paid marketing to acquire customers. Actually, most of Airbnb's users come directly to the app on their own. For Booking, there's even the term called Google Tax because of all the money they spend on Google Ads to rank number one for hotel search inquiries. In 2024, Booking spent$7.3 billion or 31 % of its sales on marketing, which compares with$7.6 billion or 56 % of sales in 2024 at Expedia. So before the call, we were joking that the thing that concerns us about these two companies and Expedia even more so than booking is if they turn off that paid marketing, it's almost like the business would just fall apart overnight.

35:08Whereas with Airbnb, they have so much more people organically coming to the app that they can spend much less. So they only spent$2.1 billion last year on marketing, which was 21 % of their sales. So Airbnb, in other words, spends much less on promoting itself. And I really see that as a testament to the power of their brand and the power of word of mouth promotion if people genuinely love the product. Expedia pays by far the most on marketing to remain competitive. And that's also why their operating profit generation is so poor compared to booking. but you know one way to gauge how a travel platform is resonating with travelers is through the percentage of traffic that comes directly to the site or app as the signals that users are organically aware of and find value in the customer experience and so in june 2025 49 percent of bookings traffic came directly where people you know search for booking.com specifically and then at 45 % at Expedia, but the number was 63 % for Airbnb.

36:18So structurally, more people are beginning their travel searches by typing in Airbnb than they are by typing in Expedia or booking.com by name. I'm actually surprised to see that even booking has such a high percentage, almost 50%, coming from direct traffic. I thought it would be significantly less, but I mean, if you look at Airbnb's numbers, over 60%, those are the numbers you love to see. It's always easy to talk about brand strength, but it has to show up in the numbers somewhere. And for Airbnb, it really does. I mean, it pays real dividends by allowing it to just structurally spend less on marketing as a share of sales, which contributes to first higher operating leverage.

36:54But then you also see the brand recognition as a legitimate mode for Airbnb and being able to protect market share or even take market share from its competition. And we will still talk about some risks later on in the episode. But I think we will see that perhaps in the future, this brand recognition becomes even more important for Airbnb. The focus is supposed to be on booking today. But one of the reasons we like Airbnb is because we believe that in the short term, good marketing can win or at least level the playing field. But long term, what wins is great products. And I think the numbers speak for themselves.

37:30else, Airbnb has the best product, which we can measure in terms of the amount of paid marketing they need to do to continuously draw people directly to their app. They could turn that off and have a much more stable business than booking or Expedia otherwise would. And for the audience, I should mention that Daniel and I were recently in Portugal together for an investing conference, and that was a ton of fun. And the reason I mentioned that is because my wife and I decided to tack on a few extra days to that trip to try and see some different parts of the country. And when we booked our accommodations, I did make a point of looking both at Airbnb and booking.com.

38:08I said this before, but genuinely, I find the Airbnb interface to be so much cleaner that the photos and graphics are way more compelling. The layout is slicker. Everything about it just works really, really seamlessly. And it just looks great. And that isn't surprising to me because Airbnb's CEO, Brian Chesky, has taken a lot of personal inspiration from Steve Jobs. And I think he has a background in photography. So that really resonates still in the product today. And we found some really beautiful and unique villas to stay in on Airbnb. And then when we looked at the same towns and cities I'm booking, the first results I came up were hotels.

38:47And then just generally the experience felt a lot messier and even just less exciting because it felt more corporate. I don't know. Whenever I opened the Airbnb app, it's almost like an adventure. There's something kind of inspiring about it. And yeah, this is the point where we should say that we're not paid by Airbnb to say that. We just really genuinely love the product and we are shareholders in it. And so booking is excellent at giving you the most options to choose from with the most specificity for your search criteria. But I do think that can be pretty overwhelming. It's like analysis paralysis.

39:24More options is actually not always better. You want maybe a more refined list of higher quality options. And there's just so many boxes to check and so many drop downs. It's a lot going on. Maybe I sound like a spoiled user, but I open booking and I'm like, oh my God, what is going on here? So, you know, maybe we have some biases because we're Gen Z or because we have Airbnb in the portfolio. little, but I really genuinely believe that Airbnb is superiorly designed product, which is not to say that we think booking is a bad investment, but I think it's important to have an appreciation for the pros and cons surrounding these different companies and what their competitive advantages are.

40:05There are certainly things that booking does better than Airbnb. And so booking has, at the same time, been able to build a real moat around its business and has generated very attractive returns on capital for a long time now. So clearly they're doing something right. And us being snobs about the aesthetics of their app has not been overly punitive to the business. Yeah, maybe just some numbers to shift the narrative here to booking. I mean, 29 % return on invested capital, 33 % operating profit margins, double digit annual compounding of EPS over the last decade, a 20 % revenue cager since 2022, and billions of dollars toward buybacks and dividends each year.

40:48All of that points to what I would say is a pretty incredible business. And that just goes to your point that they're definitely doing something right. And for all the aesthetics that Airbnb might be better at, Booking.com is a fantastic company. And Booking is a position to do more than just accommodations. And that's something they talk about a lot with this idea of a connected trip. booking your flight, rental car, hotel, spa trip, and private dinner all within the same ecosystem and app. And then having them synced up so that if your flight is delayed, then your connecting flight automatically gets rescheduled for you and your rental car pickup gets pushed back too, for example.

41:29That's the idea of a connected trip. And so the reason they're better positioned to implement this all-in-one integrated travel service compared to Airbnb is that Booking runs a variety of websites. So you can book flights, rental cars, and hotels all in their ecosystem and even make dining reservations via OpenTable too. And Airbnb is trying to do more than just vacation accommodations, but Booking already has the brands and infrastructure in place to tie all aspects of planning a trip into a single platform, which to be clear, they haven't tied that together yet, but Glenn Fogel has been pretty clear that's the direction they're moving in.

42:06And so I should also say that I wouldn't be pitching booking.com if I didn't think there's room for a few different major players to dominate global travel looking forward. I don't think it's going to be a winner-take-all business. It does seem like there will be more of an oligopolistic equilibrium where you have a couple major players that can do very well. And so according to Morningstar, in alternative accommodations at least, Airbnb has a 45 % market share. and then they believe booking has about a 35 % market share with alternative accommodations only being about a third of bookings overall business though.

42:45So Airbnb has a bigger market share but also booking is much more diversified of a travel agent business. And yeah, that does come with what we've described as more generic services and offerings. It's still, it has the widest selection and really the ability to truly plan and book your trip all in one place. which I think Airbnb is working toward, but I can't book flights and rental cars on Airbnb. And maybe one day that'll be possible, but that's just not the status quo presently. And so for the most part, this is why we said that they do different things and also they dominate different geographies.

43:25But it does seem like with experiences, Airbnb is clearly, that's their first move to kind of tangibly branch out beyond accommodation. So while there is still some distance between the two companies for now, it does seem like maybe in the really grand scheme of things, they could be on a collision course over the next 10 to 15 years. To me, it sounds like this idea of having basically your entire trip booked just through booking.com would be a huge value add. as someone, as you know, who has experience with having flights delayed or canceled, the idea that I would immediately get another flight, even if it's a totally different airline, just seems like a huge value add to me.

44:10But I think we have to talk about another topic that we kind of talked about a bit before. And to me, that is just a question of with booking.com, they seem to be primarily an aggregator of hotel listings, as you said. And with these hotels, also having their own websites where folks could just cut out the middleman and book directly with them. So what is stopping these hotels from just leveraging booking.com to ultimately drive more traffic to them directly? Like if hotels were to consistently reduce the price of direct bookings, such that people use booking.com just to search for the real property, but then they would lean to go directly to the hotel side to complete the booking at a lower rate.

44:48That seems like it would be very problematic for booking.com, right? Especially if you think about the US market, and maybe even the European market slowly moving toward more or bigger hotel chains that have more leveraging power than the smaller ones currently have? I would bet that booking could pretty quickly identify hotels that were doing this and then penalize them in some way, maybe de-emphasizing them in certain search results, for example. But more concretely, in most countries they operate in, they have something called the price parity clause protecting them, which means hotels can't legally advertise a lower price on their own websites than what they offer in booking.com or any other OTA.

45:31At the same time, there are countries like your homeland, Germany and Austria and Sweden, Belgium, Italy, and also France that don't allow this clause. It's actually illegal. So hotels in these places can theoretically charge less on their own sites than the prices that are shown on a website like Booking. And given that Booking's primary market is Europe, it is a bit concerning to me that a number of these major European travel hubs do not provide the same protection to online travel agencies. I'm not surprised that Germany is on that list. A clause like that, it really sounds illegal to me being from Germany, but also just from many other companies, but also just in many other countries in Europe as well, which probably just means that, as you said in the beginning, the more likely scenario is that hotels do not want to get on the bad side of booking.com, knowing that they just deliver a lot of traffic to their sites.

46:29And one of the interesting things I came across in my prep for this episode was that booking seems to really benefit from some tax advantages that come to it via operating out of the Netherlands. So how material is that benefit? And for the audience, can you maybe explain how exactly booking is capitalizing on this Dutch tax law? Gosh, tax stuff is always wonky. But the Dutch do have something called an innovative box tax, where any income from qualifying innovative activities can be taxed at less than 10%, which is a pretty big break relative to the normal 25 % corporate tax rate in that country.

47:12And so in 2024, this innovation tax benefit reduced Booking's tax expense by something like$600 million. So that really does materially lower their effective tax rate. Despite being listed in the U.S. as a stock, Booking earns 90 % of its revenue outside of the U.S., which is what opens the door to these kinds of tax breaks in other places. And for more context, Booking is a Dutch taxpayer with qualifying R &D expenses and intellectual property. So Dutch taxable profits linked to that IP can go into this innovation box. And then to keep their eligibility for this program, basically, they must renew their R &D certificates every six months.

48:01And so that's kind of the nuances behind the scenes. But in comparison, the U.S. has pretty stringent laws about being able to redirect revenues to subsidiaries based in lower tax rate countries. And so there are residual taxes that they must pay in the U.S. that do offset some of the benefit here. But still, Booking's effective tax rate last year was 18.9%, which is almost three full percentage points lower than Expedia's, which, as we know, operates mostly in the U.S., and almost two percentage points lower than Airbnb. be. And so maybe that doesn't sound like a ton, but an extra few percentage points a year of operating profit converting to net income for companies that are generating billions of dollars in revenue.

48:48I mean, that can compound very meaningfully in Booking's favor over the long term. So obviously, I'm not a Dutch tax expert and I don't have a strong opinion on whether these innovation benefits will continue or go away or change. But for the time being, I do think it's more interesting than anything. And it kind of helps to explain why on the margins, booking has looked like a lot better business than Expedia, at least, and has been able to outperform the market averages for some time now. Another thing that I think we should discuss, which is also a bit more interesting than taxes, is how booking has really two different models for how they get paid by facilitating hotel bookings.

49:31Can you maybe give some more insight on that and how it works exactly? Yeah. So the two different revenue models sitting inside booking are known as agency and merchant revenues. And historically, booking.com has primarily earned revenues via an agency structure, meaning they don't collect payment directly from the traveler. Instead, customers have to pay when they check in at the hotel instead of at the time of booking, at which point booking records a commission from the hotel when somebody completes their check-in. And from a cashflow perspective, this is a lot less desirable because they're getting paid much later in the process.

50:11There's a delay between when the booking is made and when the check-in actually occurs. So in the last few years, booking has moved to directly facilitate these purchases themselves, allowing them to get paid up front, keep a fee for themselves and then at a lag remit the rest to the hotel partners so kind of flipping the paradigm and without getting into a tangent on the benefits of negative networking capital for free cash flow intuitively i think we can all agree that just simply speaking the merchant model is more attractive if it means you know if you're getting the same amount of dollars in total either way but in one model you're getting paid sooner then who wouldn't want to be paid sooner So of course that's better.

50:56And while they did have to build the software infrastructure to process those bookings directly themselves, they now have that in place. And that also allows them to keep much more customer data themselves if they're the ones being the merchant of record facilitating the checkout. So they're directly interfacing with customers and recording transaction details in a way that they used to let hotels handle. And so like I said, from a customer loyalty and data perspective and from a cash flow perspective, there are some real advantages to handling this themselves. I'm looking at your financial model right now for booking, and I can see that since 2013, the agency revenues where they get paid at the end of everything has declined from as much as being 76 % of total revenues to just a third of revenues today.

51:45While merchant revenues are the inverse and have risen from being one third of revenues to over 60 % with the remaining differential being revenues from advertising, which has also taken off in the last few years. That's a pretty good result. The change has not been subtle. And again, the way to think of it is that if you go to booking and plan a trip and then at the end you opt to pay online via booking's payment portal, that would be a merchant-based checkout. Booking is the merchant. Whereas if you don't get billed until you physically show up at the hotel, whenever your trip is, then booking acted as an agency and the hotel is technically the merchant because you're checking out in their place of business.

52:30So while I do think broadly speaking, the transition to merchant revenues has improved the quality of bookings business, that doesn't totally come at the expense of their supplier partners. When booking is a merchant, they do the heavy lifting and managing the costs of fraud screening, chargebacks, credit card validation, and then dealing with no show and cancellation fee collection. So being the merchant effectively comes with more overhead costs and responsibility. And I don't think it's a coincidence either that bookings push toward being a merchant over being an agency has corresponded with their growing role in alternative accommodations.

53:12If you're working with really small hotels and hostels or Airbnb be like short-term rental properties, then these partners are going to be much more willing to outsource payment processing to booking. Whereas Hilton or Marriott want to do that and can do that themselves. But being the merchant of record is what makes it feasible for them to bundle flights, stays, cars, tickets, insurance, and all that into one checkout. So for them to be able to realize their vision for connected trips, which is really the next big opportunity for the company, they have to be the merchant. You have to do that upfront when you're checking out.

53:55You can't offer the same connected flight with an agency business model. So strategically, beyond the kind of like practical reasons that this makes the business higher quality, they can't realize this much bigger vision without transitioning to being the merchant on record. Again, I didn't know that booking is that big and being a one-stop shop for booking everything from flights to rental cars to hotels. But considering that, it makes a ton of sense to shift as much volume as possible toward the merchant checkout. But however they're doing it, they are a capital return machine. In quarter two of this year, they generated over$3 billion in free cash flow, spent$1.3 billion on share repurchases with more than$24 billion still remaining on their buyback authorization while also declaring a dividend of$9.60 per share, which comes out to over$300 million.

54:50So you mentioned the financial advantages of the negative working capital that comes with the merchant model. But I think we should also highlight that because of the ongoing share buybacks and the large cash balance, booking actually has negative invested capital as well. And I mentioned that because these attributes can skew traditional return metrics like return on invested capital and sales to invested capital. And they've bought back so much stock that their treasury stock now exceeds the common equity value of the company for accounting purposes, meaning that the equity is recorded with a negative value.

55:24And obviously that doesn't mean booking isn't worth anything. It's just this weird accounting byproduct that tries to reflect the implications of buying back so much stock. But yeah, if you don't make any adjustments to this, returns on invested capital would look negative, which is clearly misleading because it's really the opposite. The company is so profitable. They've been able to buy back such a large amount of stock that from an accounting book value perspective, the shareholder equity is recorded as being negative. Okay, so that was a bit of a tangent, an accounting tangent actually. but I thought it might be interesting to some, especially if you just look at the numbers and you get a bit confused of why this pretty good company should have negative returns on capital.

56:06But how about we zoom out a bit and look at Booking's presence globally? You said they are the world's biggest travel company, but how about we dig into that a bit more? How exactly is the picture looking? In developed markets, replicating Booking's network effect like it has in Europe has been challenging for competitors, given that around 60 % of all hotels in the region are classified as small boutique establishments, as we've mentioned a few times here. So getting those smaller, less sophisticated hotels to rely more on other OTAs, I think is easier said than done if they're content with the existing relationship they have with booking, which working well for both sides.

56:51So for the most part, Booking's advantages in the developed markets it competes in have been very sticky. But in emerging markets, the picture is a bit different. Booking does have a presence in China via partnerships with Trip.com and Meituan. But for the most part, in China at least, Fogo has said that they just don't expect to be able to win there. It's not really in the cards. They can do some business routing global travels inbound to China, but with Chinese citizens traveling domestically or internationally, Booking just doesn't seem to think that they have a way to win over those users.

57:27They've already gotten used to using other platforms. Outside of China, though, I think you could argue that Booking is well-positioned to capitalize on emerging markets traveling more, given that increased travel tends to correlate very strongly with rising incomes. And so the other thing that bulls would point to is that as a larger percentage of the world owns smartphones, that also increases the addressable market for bookings app. And we know that app users tend to be more loyal and better customers than the ones they can acquire with paid search ads on Google. Typically, they already get more than half of their bookings directly and more app penetration should increase that.

58:09The other thing is that mobile bookings tend to be less costly. So management actually thinks they can cut 400 to$450 million in costs over the next few years, which is equivalent to about two to 3 % of their 2024 operating expenses. And my feeling is that bookings dominance as a global online travel agency should strengthen over the next decade, driven by this healthy position in the Asia Pacific, where they control about one quarter of all room nights booked via Agoda, while continuing to boast 50 % plus market share in Europe with an expanding presence in vacation rentals, restaurant bookings, experiences, flights, and payments.

58:48So the flywheel should very much keep spinning in bookings favor. I really shouldn't be that surprised by those numbers, but even that they have 25 % market share in the Asia Pacific region, it's just totally surprising to me. I guess it's just so easy to fall into the trap of drawing conclusions about others from oneself All of my friends use, as we, I think, mentioned like 10 times today, Airbnb to book their trips. But we are all the same age group. And the more I travel from business, the more I come to appreciate the consistency of booking.com offerings. Still, 50 % market share in Europe and perhaps more impressively, 25 % of all rooms booked in the APEC region.

59:27Those are just very bullish numbers. So perhaps let's look at the other side. What would the bears say? Where can the thesis fall apart for booking.com? Yeah, it's pretty incredible that for a number of companies we've covered, Alphabet just keeps coming up as one of the biggest competitive risk factors. And that speaks to just how incredibly dominant and huge and innovative Alphabet really is. From the trade desk to booking, Uber, Reddit, and even Adobe, so many of the companies we've dove into on this show are at risk of being directly or indirectly disrupted by Alphabet. it. But yeah, once again, Google is a big consideration here.

1:00:09Google has its own meta search travel platforms that rival Kayak more so than booking.com. But still through Google, you can explore flights, hotels, and vacation rentals. And to the extent that they want to continue placing ads for their own platform over organic search links could require companies like Booking and Expedia to have to spend even more on marketing to maintain market share. And maybe Google doesn't even want to seriously disrupt either of those companies, but just by making it harder for people to directly navigate the search results that lead to booking, again, booking has to make up for that with more sponsored search campaigns, which puts more cash directly in Google's pocket.

1:00:50So they might even have an incentive to do that. So in other words, assuming Google doesn't want to become a full-fledged OTA like booking, which was a concern previously but really hasn't manifested, they can still push OTAs to increase their marketing budgets to ensure that people go to Booking.com to check out flights instead of visiting the default in Google Flights. And at 30 % of sales, a couple percentage points increased in those marketing expenses would be very substantial for booking and would materially be a headwind to profit margins going forward. Just as, you know, a 2 % less of a tax rate has a huge impact.

1:01:34If you have more marketing costs on the other end, it's a huge impact as well, even if we just talk about a couple percentage points. I think what even made us more bullish on Google than the actual episode that we did many months ago was just seeing how much the ecosystem has impacted other companies when we looked at them or researched them. By leveraging its dominance in search, its Android mobile operating system and its integration of travel services into products like Google Maps, Google can, like you said, favor its own travel offerings, such as Google flights and Google hotel ads directly within their search results.

1:02:08They're really in just such a powerful position to influence consumer choice and potentially divert traffic from other online travel platforms. I think regulators would take an issue with that kind of favoritism toward their own interests if they did it too explicitly. But yeah, it was eye-popping for me to come across stats saying that around 81 % of travelers use Google search as their top source of travel inspiration and 91 % use search engines in general when looking for a place to stay as long as chat GBT doesn't totally flip that paradigm upside down Google is this unavoidable intermediary between OTAs and consumers with OTAs themselves already being intermediaries between customers and hotels or airlines and beyond search they just have such a strong ecosystem to lean on.

1:03:00For example, having flights and hotels embedded in Google Maps is really compelling. If Google wanted to increasingly become the merchant of record for these transactions and build out the ability to directly book travel with Google, I mean, gosh, it would be hard to pretend like that wouldn't be massively disruptive for booking. And so right now, Google will show you a hotel listing. And if you click on it, you'll probably get redirected to booking.com or that hotels website that is the status quo and there are good reasons why alphabet has been hesitant to take on more of a merchant role and all the costs and overhead that goes with it but still that status quo just feels a little flimsy to me it feels like there's a large opportunity being dangled in front of alphabet that they have decided isn't worth taking on for the time being but the calculus of that decision and whether it's worthwhile for them to disrupt booking could change in the coming years as the way we book travel shifts more to agentic commerce and using large language models as opposed to really how we book travel today.

1:04:10So taking it all together, you've got direct competition with Expedia and Airbnb, but also there's indirect pressure and potential for much more pressure from Google. And at the same time, I think it's also not like traditional hotels are standing still either, right? I mean, hotels are always trying to increase their direct bookings and they use loyalty point systems to chip away at OTA share for customers, even if there's price parity between what a hotel can charge for a booking.com listing and a direct listing on their website. If customers lose out on hotel loyalty points by not booking directly with the hotel, then that's another subtle factor that might drive you to, you know, straight go to the supplier instead of a middleman like booking.

1:04:54I know booking also has a loyalty program. So really, it sounds like it's a competition between loyalty rewards, which can still be quite expensive. And the other thing is that you made a comment talking about the status quo, assuming ChatGPT doesn't flip everything upside down. But that's another real threat that booking has to at least content with, right? I mean, I'm imagining a future where you have some digital travel agent via ChatGPT that books and plans trips directly and on your behalf. And rather than going through a middleman, OpenAI routes these agents directly to the source to book trips.

1:05:29In that case, if we went long booking, we would not only be betting that booking will still have a significant role in a world where LLMs are much more involved in the travel process, but also that specifically Booking can develop AI agents and tools for that matter to connect trips that are more compelling than what OpenAI can develop within ChatGPT. And I don't know about you, but I must admit that does give me some pause. It's a question that matters for many, many more companies than just Booking. But still, if ChatGPT isn't aiming to disrupt just Google search, but actually the entire desktop, then there's a legitimate question of whether OTAs like Booking will be phased out with them.

1:06:10It also makes you question the decision we made a few months back. We had a member of our intrinsic value community approach us with the opportunity to invest in a fund that would give us exposure to open AI in their latest fundraising round. And we passed. We thought the valuation at$500 billion was kind of crazy. But yeah, I don't know. There are definitely been times where I've pinched myself. I think ChatGPT recently came out with a browser. You think about the ways that they can drive a gent at commerce. And you're just thinking, man, maybe this is a potentially multi-trillion dollar company.

1:06:52Sean, it's even worse. We only needed to pay 300 billion, not even 500. You're right. You're right. Yeah, we might regret that. so I think it's a really compelling counter argument Daniel I thought about similar things and so that's why I really did want to discuss booking with you so we can try to wrap our heads around what has been emphasis on has been such an incredible business that we think should continue to be an incredible business and maybe even a better business unless ChatGPT and LLM just totally rewrite the status quo which is certainly possible and is a question we're asking about a lot of the businesses we own.

1:07:36And if it's not chat GBT, we talked about Google, mainly from the Google search perspective though, but they also have their own AI platform in Gemini. And maybe they use that as their chance to disrupt booking and this new domain with AI agents that book trips on the user's behalf. To grow and even just maintain its industry leadership over the next decade or so, booking will need to adapt to challenges on multiple fronts. Now you can see why they're so keen to build brand loyalty with direct customer traffic to their website and app. They want to act more like a merchant than an agency. And then just generally, they want to reduce their reliance on any single gatekeeper, whether that be Google today or chat GBT tomorrow.

1:08:16And I do think that's a tall order. And before we even get to the valuation, I do wish that these risks were more priced into the stock than they are at a mid 30s P multiple. it's just difficult to argue that the market is as concerned about some of these risks as we are right whenever you're paying a substantial premium over the S &P 500 which you probably argue is already richly priced at significantly above average historical multiples it does not feel like there's a substantial margin of safety baked in at those kind of valuations with 460 million plus monthly visits to booking.com though, that beats the web traffic that Expedia, Airbnb, and trip.com all received by several times over.

1:09:03And so booking should in theory have multitudes of invaluable customer insights that are hard for others to produce without years of being able to observe traveler behavior at that same scale. And I also tend to think that most human travelers with the keyword there being human will value comparing pictures, locations, and the amenities of accommodations themselves, which is where booking is able to differentiate itself and suggests that most travel planning, if not almost all of it, will not get routed through LLMs and AI agents in the coming years. And that's not to say people won't use AI to help them brainstorm and plan the logistics of a trip because that is already happening.

1:09:47But at the same time, I'm not sure that, you know, that doesn't mean that people want to make the final booking and purchase decision via chat. We actually still need to see if that happens at scale. And to me, that's a different thing. That's much further off in terms of us all getting comfortable with AI today being so deeply entwined into our personal finances. I still think people want to see the options for themselves. And, you know, booking really has the best interface to provide that. which is not to say that ChatGPT couldn't create something similar though. Actually, a few doubts about ChatGPT and LLMs getting more ingrained in our personal finances pretty soon, but still, it's just so easy to get lost in all of the what-ifs of AI and the future.

1:10:33So let's make some things more tangible again. And that is to say, booking just gushes out free cash flow, giving them a ton of funds to return capital to shareholders, which is always what we like to see. And that's always interesting to me when companies choose to offer both dividends and share buybacks. If the company has such compelling growth prospects, then reinvesting their retained earnings should be the best use of that capital, right? If some amount does need to be returned, then being a share cannibal and buying back their own stock can be an effective way to grow earnings per share and return capital to the shareholders in a significantly more tax efficient way since investors have to pay income taxes on dividends, but they do not have to pay any taxes on repurchases.

1:11:17So why then, at least that's what I'm asking myself, are they allocating some of that free cash flow to dividends instead of reinvesting it in the business or buying back even more stock? It's a tricky question. On the one hand, I think it's fair to say that we'd probably prefer the company not to pay a dividend at this time, given the growth prospects they have before them. But even after initiating a 20 % quarterly payout of dividends in 2024, the company generates more than enough cash flow to both invest in the future and return capital. And because booking does buybacks opportunistically, meaning they don't just blindly repurchase X by Z number of shares every quarter, regardless of valuation, which is a good thing for the record, that can cause big swings in how much stock they're buying back while cash continues to accumulate on the balance sheet at a more consistent rate.

1:12:09So I think the dividend program is almost just a way to consistently pay out a small portion of their earnings that smooths out the capital returns over time. So I'm not sure if it's theoretically optimal from a value creation perspective in the way that we might learn in financial valuation class in college. But I think it does strike me as being pragmatic. If they were paying out like 60 % of earnings in a dividend or something like that, that would be more problematic. But it's such a small percentage of the overall pie that I get why they do it. Plus, it's coupled with buybacks that are really, as you said, opportunistic, which is something I always like to see.

1:12:52It's one of the great arguments for Copart in my mind where they only buy back stock when it actually moves the needle and it's at a reasonable valuation. But one other thing I need to discuss is executive comm. I don't think we'd ever rule out a company for disagreeing with their decision to pay a small dividend, but we would rule out a company. We already have done so if the incentives for management are not sufficiently aligned with what we believe is best for shareholders. So how would you say to us the executive comm structure for Booking.com looks like? I totally agree. And this is one of those things that we've learned to focus more on, I think, as we've become more sophisticated investors, right?

1:13:29At first, people spend a lot of time looking at valuation ratios and maybe they learn to appreciate some of the more intangible concepts like competitive moats, flywheels, and having a margin of safety. But really having a careful consideration of management comp is something we've learned from investors who are savvier than us. I think that was one of our main takeaways from Joseph Shepochnik, who we hung out with in Montana back in September. And he gave a really great presentation on the importance of management compensation. So when it clicked for me why management comp is so important and how to think about it, that felt like a really big stepping stone moment in my investing journey.

1:14:07And so anyways, for booking, the primary components of their executive compensation include a base salary, an annual cash incentive bonus, and then long-term equity awards. And that last point on long-term equity awards is the one that's really worth digging into. And about 60 % of that comp comes from what's known as performance share units, also called PSUs. Well, 40 % is related to restricted stock units, which just means that management needs to stay with the company for a certain amount of time to unlock part of that payout. And so we've talked about this before, but I'm not a big fan of RSUs or restricted stock units.

1:14:53I don't think you should get paid simply for staying at the company. Your performance-based incentives should be all that's needed to motivate you, in my opinion. And if you can't meet those goals, then that manager should be replaced and not rewarded with the executive comp equivalent of what I think you could call a participation award. I think what's potentially even worse than the RSUs is how they award stock grants on a performance basis. The metrics they use to determine performance, at least to me, just don't seem to even remotely align with what's generally best for long-term shareholders.

1:15:30It does concern me because it's one of those things that it sounds good on paper, but it does not hold up to scrutiny. And so for the performance-based portion of their long-term stock awards for management compensation, They focus on revenue and adjusted EBITDA, first and secondly, which is, boy, that's tough to swallow. Anyone who has read The Outsiders by William Thorndike will know what I mean when I say that. Revenue growth does not equate to intrinsic value creation if the revenues are low quality or not profitable and yielding returns above the company's cost of capital. So encouraging management to focus first and foremost long term on revenue growth.

1:16:13That is a big red flag to me. And then I won't even dignify adjusted EBITDA with a comment. I mean, it's just a completely fabricated accounting number that companies all define differently and use simply to try and put themselves in the best light possible. And it has nothing to do with long term value creation. And then the third criteria they focused on is broken out into total shareholder return over a number of years, as well as the relative returns of booking versus a group of peers. And once again, that sounds pretty good, but it is disappointing beneath the surface. The peers that they grade the company's performance against and use as a basis for executive compensation is diluted by a number of airline companies, which have these very poor records of generating returns for shareholders, in addition to these capital-intensive cruise companies that really have nothing to do with booking.com.

1:17:11And so when Joseph gave that presentation to us in Montana for the TIP summit about management compensation, what he really leaned into talking about was how companies can cheat their peer group comparisons by watering them down with low-quality companies that makes it easier for them to seem like they're outperforming their competition. But it's all kind of fake. It's a facade. And so for booking, their more legitimate comps like Airbnb, Expedia, and TripAdvisor are diluted by these less relevant peers, these inferior peers. So for a company that has actually done such a good job creating value for shareholders over time, I honestly, I found it's shocking and surprising to see that this is how the comp structure is assembled.

1:17:58They factor in absolute total shareholder return, which is a good thing. But when three of your four criteria are inappropriate benchmarks to assess management against long-term, then having one of those being directionally more correct can only take you so far. As you mentioned before, our colleagues Clay Fink and Kyle Greve have actually done a wonderful job covering booking earlier this year. So how about we just listen to their conversation about bookings, incentives, and comp for management? You know, when I was reading through sort of management incentives and shareholder alignment, I sort of posed the question to myself, would I rather invest with the management team with exceptional performance and a so-so incentive structure, or would I rather invest in the opposite, where you have exceptional incentive structure, a so-so performance in terms of the business.

1:18:49It's pretty clear which one I would choose if I had to choose between the two. And it's also interesting that in aggregate, their stock-based compensation levels aren't nearly as bad as you would think, given that they're a tech company. In 2024, they had stock-based comp of$600 million. That's a 0.3 % dilution rate, and it's a 2.5 % of revenue. That seems pretty reasonable to me. Airbnb, on the other hand, they have$1.4 billion in stock-based comp, which is a 2 % overall dilution rate. And then when I look at the other executives, I see a similar dynamic to Fogel where their total comp is pretty high, decent amount of skin in the game, but not quite as much as I'd like.

1:19:32And you looked into the incentive structure for management. So how about you dive into that? Absolutely, Clay. So being like a lot of other companies has both a short term and long term bonuses. So let's go over the short term bonuses first. So short term bonuses are cash incentive bonuses that are based on a combination of company financial performance and individual performance. So the company's financial performance is based on adjusted EBITDA. Now, for most businesses, I think this is just a very mediocre performance metric. However, booking has done a very commendable job of specifically excluding share-based compensation from adjusted EBITDA, which I 100 % applaud them for because there's very few businesses that'll do that.

1:20:13Now, as for individual performance, they're based on several intangible factors, such as the achievement of strategic and operational goals, leadership, talent development, risk management, and ESG contributions. So the short-term bonus is capped at 200 % of the target bonus. So in 2024, the target bonus was$6 million. This means that if all KPIs were achieved, Fogel could earn up to about$12 million in short-term incentives. Fogel ended up earning$7.8 million in short-term incentives, which is about 130 % of the target. Now let's look at the long-term incentive program. So the long-term incentive program is comprised of both the reserve stock units and the performance stock units.

1:20:53So, you know, looking at this, I think the incentive program is decent. It's not the best I've seen, but it's also not the worst. I love seeing performance metrics that are based on capital efficiency and per share metrics, but it's also just pretty rare to see this. I'm not a huge fan of total shareholder related performance metrics because I think a CEO can often receive a very large bonus simply due to market sentiment. So at least they have the three year period to look at. I prefer metrics that focus on value creation. So seeing that they have metrics at least that are in regard to revenue and EBITDA.

1:21:25I think that's decent because I think if the business continues driving revenue EBITDA, the business is probably going to be building its value for shareholders as well. There are always different opinions on everything. So I'm glad we could loop in Kyle's thoughts. Besides fears about AI and Google, if there were a reason for us to pass on booking, to me, it would boil down to what I found to be a pretty disappointing structure for a company that has been such a high quality combat on turn. It's just another question mark around the durability of their competitive advantages and ability to generate excess returns on capital long term.

1:22:03I'm equally, I would say, surprised by the suboptimal capital structure but I think I would go with Clay on this one where if the company has proven to outperform, I'm willing to give it the benefit of a doubt when it comes to the compensation structure but it would be something that has to be consistently looked at and you have to keep an eye on it at all times. Okay, so before we get to the valuation, which is the last part of every episode, whenever we do a deep dive like this, I did want to revisit the topic of AI one last time because I saw an interview with Time magazine that Booking CEO Glenn Fogel did and he said in regards to AI that it will be, quote, almost like booking.com would have a memory of you and understand what you want.

1:22:46Let's say you are at the airport and you get a text from the airline that says your flight is delayed four hours. Pretty annoying, but I'll bet they never sent you a text that said your flight is delayed four hours. However, we have a competing airline that's departing in two hours. We'd be happy to switch your ticket right now. We should be offering that up to you, making it easy for you before you even know there's a problem by offering a solution to that problem. Point being, and these are my words now, there is a need for an objective third party to be involved in the process that's devoted to finding the best possible outcome for the customer, not just what's in the best interest of a specific airline or hotel.

1:23:28So whether that intermediary longer term is booking, Google, ShedGPT or someone else, I suppose it's still up for debate. But there is a huge need, I think, in this service. and booking has a pretty good starting point to become a market share gainer in that aspect. The good thing is that if we did invest in booking, I think we'd have some time to reflect on that further. In the next 12 to 24 months, I'm definitely not anticipating that the way we plan or book trips will fundamentally change. Oh, if I'm wrong about that, this will look really bad, but it's not my baseline. Unfortunately, travel is one of those things that is really like a basic need for human beings.

1:24:09If you look over a long period of time, like 100 years, travel has always been growing as an industry and it's been growing faster than GDPs. And really that's because as people get wealthier, going from poverty to the middle class, one of the first things they want to do is travel. We talked about that earlier with emerging markets. And even as people get to the point of being wealthy, they may not travel more incrementally, but they will go to more expensive hotels and pay for business class or first class on flights. And so basically just everybody ends up spending more on travel over time.

1:24:47And that's been happening for decades. So I don't think I'm really speculating at all. Nobody knows what will happen with the economy and how that will affect travel over shorter periods. But long term, I almost cannot imagine a better industry to bet on being able to outgrow GDP with a very low risk of being wrong. All right. Well, I would say it's finally time. Let's try to pull everything together and look at our, or more so, look at your valuation model to decide if we can both get comfortable with investing in Booking.com for our intrinsic value portfolio. you? This is a company that the market has happily paid a premium for years now.

1:25:29Booking's median price to earnings ratio has been at times nearly double that of the S &P 500 with a median PE of 32 times since 2016, 30 times since 2019, and more recently still a 28.4 times multiple of earnings over the last three years. So for the most part, the company has traded in a relatively narrow valuation band, which signals to me that investors feel like they understand the business pretty well and appreciate its quality. It does not go on sale very often and a dramatic discount in the stock would still be something like 20 times earnings, which many people would not call cheap at all.

1:26:07With the exception of the pandemic in 2020 and the bounce back year in 2021, bookings operating margins tend to hover around 30 % or so, which is very good. That's almost exactly on par with a tech giant like Alphabet. It's not an apples to apples comparison, but I just had to emphasize that their profitability is in line with some of the best tech companies in the world. And I think as the company has assumed the costs that go with being a merchant more so than an agency, operating margins have moved modestly lower in the past, but still it is a very profitable company and one where I think there's certainly further room to expand margins, especially with some of these large cost-cutting initiatives that they've announced?

1:26:51I think it's safe to say that we are in an agreement that there are probably some concerns that we could cop out to but at the same time this is just a pretty dang good business that has proven it deserves a premium valuation and the question that we now have to answer is is the current price reflecting too much of a premium such that we want to pass on it? I mean just a couple of days ago, we talked about the current valuation of the S &P 500. And we were both surprised that it's currently trading at about a premium, or not a premium, but a valuation of 28 times earnings, which is significantly higher than both of us thought.

1:27:26And we kind of looked at the companies that we own and saw that most of them are not trading, even the ones that we passed on due to valuation, are not trading that much above that. And you just said for the last three years, Booking.com is trading at a valuation of 28 times earnings. So what do you thing? Should we pass on it for valuation concerns? Are there other concerns that overweigh the valuation? What is your decision on the company? Assuming that booking can continue to compound revenues at nearly 10 % a year while getting some further improvement in operating margins and continuing to buy back shares aggressively and pay a modest dividend, I think it would be very reasonable for an investor to underwrite an expected return of 15 % a year over the next five years, which even includes a more than 20 % contraction in the PE multiple from current levels in that number.

1:28:14So to say that again, you could have a moderation in the valuation while still comfortably being able to expect, I think, a 15 % plus IRR, which is not something we see in a lot of the companies we look at. And that return comes from expanding further in emerging markets, driving more people to book flights and rental cars. At the same time, they book their hotel on booking.com, cutting back on costs, buying back shares and returning cash via dividends. There's just a lot going on that is favorable to shareholder returns. And even in a less optimistic scenario, as long as the business is not seriously disrupted in a worst case scenario, it would be hard for me to envision them not still having pretty solid returns with even minimal organic growth just because of the buybacks and dividends they're able to afford because the business is structurally so profitable.

1:29:11But again, the big if is if they get disrupted. And that's where I feel like things are just really shaky. If I had to guess, I'd say that booking has been around for decades and has adapted to many different permutations of the internet. So I suspect they will continue to find new ways to thrive since I do believe that there is value in neutral OTAs that legitimately help travelers and also support airlines. hotels and rental car companies too. At the time of recording, the S &P 500 trades at about 30 times earnings, but booking trades at 36 times earnings. So that difference from 30 to 36 is a 20 % premium.

1:29:51And paying a 20 % premium does not feel like a margin of safety that reflects the disruption risks that we think are on the table for booking. On top of the fact that we're very displeased by their comp structure. So if I felt management was better aligned and I could get myself comfortable with the unknown unknowables here, where you have a situation where maybe there is a little bit of margin of safety, maybe we're buying it 25 times earnings instead of 36 times earnings, then I would be much more comfortable with the disruptive risks and the poor management incentives. And we might revisit it at a more attractive price, but we would have to actually get that more attractive price.

1:30:35I think at today's levels, it doesn't feel like even though you could model really good returns in paper, my gut instinct tells me that it's not an asymmetric bet in our favor because I don't believe that these major disruptive risks and all the uncertainty facing the future of how we book travel, I just don't think that we're getting a price that provides us any protection in a downside scenario. I think I have to agree. We've covered by now about 47 companies on this show. And there's a selection bias here where we only cover companies that we think are great businesses. And only a dozen of those have actually made it into our portfolio.

1:31:17And the reality is that most companies, even the great ones, will look fairly valued at best at most times. So really, we're looking at these companies to get comfortable with them, such that if there's some sort of panic in markets unrelated to their core business model, we can snap up shares at a discount, which 36 times PEMultiple for Booking.com right now is fairly not. I think what I've appreciated the most about looking at so many companies is just the watch list that you build and how that prepares you for when the market gives you an opportunity. I mean, we were able to use that in some stocks in the April panic, for example.

1:31:53I think Reddit is a stock that we bought about that time, which has performed wonderful for us ever since. And yeah, I agree with you on booking. I could get over their comp structure since it seems that both in terms of management performance and capital allocation, the management has still made the best of it. But I'm a big believer, it's hard to say it like that, but I'm a big believer in agenda commerce and I might overstate its importance, but I do think it's only a matter of time. And when that's the case, it might become a lot tougher for a company like booking, which is very dependent on the ads it places on Google.

1:32:26Most likely they will figure out a way to navigate that. But right now the stock price suggests they will figure it out. And I would rather buy the company when the market believes booking will be a loser in AI and values the company accordingly. I mean, that's kind of a narrative or a story you see with a lot of companies that we own in our portfolio, probably most notably Adobe. And we talked about that a lot also in the intrinsic value community. But that's why I agree with you. I would put booking.com on the wait list and not yet invest. Well, I think that's enough on booking today. How about you give us your hints for next week's pitch?

1:33:05Well, I will keep it short. I'll cover a company that you personally know very well. And you actually pitched a competitor just a few weeks ago. And I would argue that next week's pitch, so the company that I'm going to present, is an even more diversified business, which you could argue also makes it a better business. I don't want to say too much though because it has been guessed in the comments previously and I think that most of our loyal listeners will probably already know it. All right, folks. Well, I am looking forward to next week as always to see what Daniel's pitch for me is. And to wrap up things today, let me leave you with a quote.

1:33:40This one comes from Ralph Waldo Emerson who says, this time, like all times, is a very good one if we know what to do with it. I think great long-term investments can be found at any moment in markets, regardless of how expensive commentators say the general market is. So if you know how and where to look, I think you can find very good investments at any time. And to me, that's the spirit of Ralph Waldo Emerson's quote here about knowing what to do with the opportunities before us. So it's that belief that inspires us to dig into a different idea every week on this show. See y 'all next time.