Expedia's fastest growth comes with a shrinking profit margin

Expedia's partner business is growing far faster than its familiar consumer brands. But it is keeping less of each revenue dollar as adjusted profit, while the consumer business is becoming more profitable.

That split sits behind a strong third quarter and another increase in the travel group's annual forecast. Airlines, travel agents and other partners are bringing Expedia more business. Its own brands, including Expedia, Hotels.com and Vrbo, are supplying most of the extra adjusted operating earnings.

More partner sales, a lower margin

The business-to-business division supplies travel inventory and booking technology to other companies. Its revenue rose 23% to $1.71 billion, adding $316 million, or about 60% of the group's revenue increase.

Adjusted earnings before interest, taxes, depreciation and amortization, or EBITDA, rose to $470 million from $402 million. But its margin fell to 27.5% from 28.9%: costs grew faster than revenue.

Chief Financial Officer Derek Andersen pointed primarily to the mix of partners. As larger partners grow, they move into higher commission tiers, leaving Expedia with a smaller profit margin. Investment in recent acquisitions also added costs, though management described that as the smaller factor.

The business is still earning more dollars. The trade-off is that building scale through partners does not necessarily produce the same percentage of profit on each additional sales dollar.

The consumer brands provide the profit lift

The consumer business tells the opposite story. Revenue rose a slower 6% to $3.07 billion, but adjusted EBITDA grew to $1.33 billion from $1.17 billion. Its margin widened to 43.5% from 40.7%.

Direct consumer marketing costs were nearly flat while bookings rose. Expedia said better returns on that spending, together with cost discipline, helped turn additional sales into profit.

The consumer division's $157 million adjusted EBITDA increase accounted for about 65% of the group's $240 million improvement. So the fastest-growing sales channel and the main source of extra profit were different parts of the business.

Overall, revenue reached $4.94 billion and adjusted EBITDA $1.69 billion. Both comfortably exceeded the original August forecasts, which topped out at $4.75 billion and $1.56 billion. Reported operating income rose to $1.33 billion from $1.04 billion.

The stronger quarter does not set the year-end pace

Expedia raised its annual revenue forecast to $16.37 billion to $16.43 billion, from August's $16.05 billion to $16.22 billion. It also expects greater adjusted margin expansion across the year.

Research by Ticker Byline shows that roughly 90% of the increase in the annual revenue midpoint was already delivered by the quarter's outperformance against the previous Q3 midpoint. Comparing the original August forecast with the latest results gives $238 million of quarterly outperformance against a $265 million increase in the annual midpoint.

Management expects fourth-quarter revenue growth of about 4% to 6%, slowing from 12% in Q3. It cited a softer operating environment, including travel disruptions, harder comparisons with earlier partner promotions and an autumn sale moved forward a few weeks. More of that sale fell in Q3 this year than last year.

Andersen also said the consumer business's marketing gains would be harder to repeat at the same pace. Expedia still sees room to improve returns, but it is now comparing with a period that already benefited from removing less effective spending.

Cash follows a different calendar

Third-quarter free cash flow was negative $1.40 billion, even as profit rose. Expedia collects money for many hotel bookings before paying suppliers after stays, so the busy travel season reverses part of the cash inflow built earlier in the year.

Across the first nine months, free cash flow was positive $3.63 billion, up from $2.99 billion. The seasonal quarterly outflow therefore sits alongside stronger cash generation over the longer period.

The Expedia company profile follows its completed acquisitions, cash, debt and tax dispute. The next test is whether partner growth can keep adding profit as commissions rise, while the consumer brands face slower sales growth and a tougher comparison for marketing savings.