This is a good time to be operating in the online travel industry. People are increasingly choosing to research, plan, and book their hotels and flights from online sources, and they're even open to paying for local attractions and restaurants at the same time.
That's great news for TripAdvisor (NASDAQ: TRIP), whose flagship website is one of the most popular travel destinations on the internet.
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Yet that prime market position hasn't translated into strong growth for the company lately. In fact, sales gains were a meager 3% in its core hotel segment last quarter, as net income dove by 21%.
Let's look at the prospects for TripAdvisor to post a dramatic rebound and begin generating growth that would power massive returns for long-term investors.
A huge market opportunity
The industry benefits from some very favorable growth dynamics. Global online travel spending should total $550 billion this year, or slightly less than half of the $1.3 trillion that people will spend on travel across online and offline sources. That huge market opportunity is shifting rapidly online, too. E-commerce bookings are growing at a double-digit rate, compared with a 5.5% increase in the broader industry .
With its industry-leading database of traveler reviews and photos, TripAdvisor attracts over 400 million monthly visitors across its network of sites. The company makes money when these users click over to its partner sites to make their lodging purchases. These partners pay a cost per click on advertisements that they market to TripAdvisor's users in a similar model to the one that makes Alphabet's Google such a powerful business.
As search demand increases on its site, TripAdvisor aims to boost its $1.5 billion sales base to account for a far larger proportion of that $550 billion online travel industry over time.
Three big challenges stand in between the company and that optimistic long-term result. The first is its shift toward an instant-booking model that allows users to make reservations directly through TripAdvisor. This move has improved the customer shopping experience, management says, but at the expense of sales growth. It's a key reason hotel transaction revenue has declined in five of the past six quarters.
Second, TripAdvisor is seeing a sharp move away from desktop browsing and toward mobile shopping, which is lowering the CPC rates it can charge and thus reducing revenue and profit growth. Finally, competition is heating up across the industry, and so most of the players are finding it necessary to boost marketing spending and lower the rates they charge to advertising partners.
What to watch
One of its biggest assets in this fight is TripAdvisor's healthy audience engagement. Even though sales growth was modest last quarter, hotel shopping traffic jumped by 11% to mark its best expansion rate in over a year.
Yes, many of those visitors came through mobile devices, and so they delivered weaker sales metrics as a group. However, it shouldn't be too difficult for TripAdvisor to increase its monetization efficiency over time. Meanwhile, it's a long-term positive for the business that so many mobile users are choosing to shop through its app, since it confirms that TripAdvisor's popularity is holding steady in the transition away from desktop travel search.
TripAdvisor executives are even more optimistic about their opportunities in the non-hotel business that jumped up to 20% of the business last year from 9% in 2014. CEO Stephen Kaufer described attractions bookings as "a business that basically has almost all tailwinds to it." As the company dramatically improves its portfolio of bookable experiences, it's easy to imagine that segment growing far more profitable even as it expands to a much bigger proportion of TripAdvisor's total revenue base.
Still, the company won't become a top-tier force in the industry until it can establish itself as a leading hotel search destination. That's why I'll be closely watching the hotel visitor volume to see if it continues at -- or improves on -- the healthy 11% that TripAdvisor posted in its most recent quarter.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Demitrios Kalogeropoulos owns shares of TripAdvisor. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and TripAdvisor. The Motley Fool has a disclosure policy.