OREANDA-NEWS. Fitch Ratings has assigned a 'BBB-' rating to Expedia, Inc.'s (Expedia) announced issuance of senior unsecured notes. A full list of ratings follows at the end of this release.

Expedia plans to use the note proceeds for a portion of the HomeAway acquisition and other general corporate purposes.

KEY RATING DRIVERS

Fitch calculates pro forma unadjusted leverage of 2.3x for the notes offering and all three recent transactions (HomeAway, Orbitz, eLong). This is slightly higher than Fitch's Sept. 30, 2015 pro forma unadjusted leverage of 1.8x, which does not include the HomeAway transaction. There is headroom for leverage to spike above 2.0x due to strategic acquisitions as long as Fitch views the transaction as favorable and is comfortable that leverage will be reduced over the one-to-two year Stable Rating Outlook horizon. This note offering and the HomeAway transaction fall within this context, similar to the note offering and Orbitz acquisition earlier in the year. However, there is now less headroom for any additional leveraging transactions, including material debt-funded acquisitions or return of capital to shareholders.

On Nov. 4, 2015 Expedia announced it will purchase HomeAway, Inc. for $3.9 billion. HomeAway will be the company's largest acquisition to date. Expedia plans to fund the purchase with approximately $2.9 billion of equity issuance and $1 billion of cash (comprised of net cash at HomeAway and the most recent note offering). Fitch views Expedia's planned funding mix for the acquisition as a positive and shows the company's commitment to maintaining its low investment-grade rating. The transaction has been approved by both companies' board of directors and was granted regulatory clearance by the Federal Trade Commission. The deal follows on the heels of Expedia's $1.6 billion acquisition of Orbitz, $612 million acquisition of Wotif Holdings Ltd., $270 million investment in Decolar, and $229 million purchase of corporate offices.

Fitch views the HomeAway transaction as strategically sound and gives Expedia a solid beachhead in the so-called 'sharing economy'. HomeAway helps diversify Expedia's product offering in a manner that complements its existing customer base. HomeAway's website has over 1.2 million vacation rental listings in over 190 countries, which should appeal to Expedia's customers, who are increasingly looking for and open to alternative forms of vacation lodging. Adding HomeAway will also reduce Expedia's supplier concentration at a time when hotels, for example, are capitalizing on strong industry demand by reducing their exposure to discounted inventory distribution channels (i.e. online travel agencies [OTAs]).

Fitch sees some execution risk to boosting HomeAway's monetization, which will likely require a transition away from the company's predominantly subscription-based business model to a more transaction-oriented approach that includes some upselling of products and services. Expedia's expertise in transaction-oriented business models, as well as its familiarity with HomeAway gained through their partnership during the last two years should facilitate the integration and mitigate execution risk. In addition, growth in HomeAway's overall bookings ($14 billion-$16 billion currently) should also provide additional tailwinds to the business as Expedia plans to leverage its expertise and become more aggressive through variable marketing channels.

The purchase will be immediately dilutive to Expedia's earnings. However, the company expects to more than double HomeAway's EBITDA by 2018 to $350 million from $120 million going in, primarily through organic growth and better monetization. HomeAway's monetization rate is approximately one-third the rate of Trip Advisor, Inc. and Airbnb, Inc.

Expedia's EBITDA target is reasonable given the upside potential in HomeAway's monetization rate. Fitch estimates that a 100 basis point increase in monetization rate can generate incremental EBITDA of roughly $30 million. Fitch's Base Case includes $280 million of 2018 HomeAway EBITDA, under conservative estimates around growth in HomeAway's gross bookings, monetization rate, and margin, given the timing considerations and execution risk. Under these assumptions, Expedia is expected to delever below 2.0x over the one-to-two year Stable Rating Outlook horizon.

KEY ASSUMPTIONS

Fitch's expectations are based on the agency's internally produced, conservative rating case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate. Key Fitch forecast assumptions include:

--Strong revenue growth in the double-digit range driven by organic growth and recent strategic acquisitions.
--EBITDA margins hold steady in the 16%-17% range through leveraging of fixed costs on aggressive revenue growth offset by the levels of investments in sales and marketing expense that support a longer term view.
--No additional debt raised through the forecast period as future acquisitions are in the $400 million range and funded through cash flow from operations.
--Share repurchases remain subdued until the HomeAway transaction closes, and resume at $550 million annually thereafter. Steady dividend increases consistent with 2014 payout ratio.
--HomeAway transaction closes in first half of 2016.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

--Positive rating action will likely be forestalled for the foreseeable future due to minimal business considerations to support the company maintaining a rating above 'BBB-' and certain secular challenges. These include an intensifying competitive environment, shifting consumer behaviors, and technological shifts. However, a more conservative financial profile coupled with increased revenue diversification from the growth of the Egencia segment and Ad and Media revenues could have positive implications for the rating.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

--An increase in expected volatility in profitability, potentially due to greater volatility in travel services demand or a higher fixed-cost component to Expedia's financial model;
--A secular decline in the OTA business model, potentially the result of a shift to direct bookings with travel providers;
--The potential for a substantial financial loss from any future conclusion of the occupancy tax lawsuits facing the company;
--A more aggressive financial policy, reflected through material debt-funded acquisition, share repurchase, or dividends that drive leverage sustainably above 2.0x.

LIQUIDITY AND DEBT STRUCTURE
At Sept. 30, 2015, Expedia had $1.5 billion in cash and generated $527 billion in Fitch-defined free cash flow (FCF) during the trailing 12-month period. With FCF expected to be in the $1 billion - $1.2 billion range, and an increase in cash from this note offering, Fitch believes Expedia will be able to maintain steady dividend increases consistent with the 2014 payout ratio while delevering to below 2.0x within one to two years on EBITDA growth. There is flexibility for some level of share repurchases, but Fitch does not expect repurchases consistent with 2014 levels ($538 million gross repurchases) to resume until after the HomeAway acquisition is completed. Fitch expects Expedia to grow its cash balance over the next year as the company has historically held outsized cash balances to partially offset the working capital deficit.

HomeAway has $403 million in 0.125% convertible notes which Fitch assumes will be converted or repurchased by Expedia. The convertible notes contain certain clauses that, under specified corporate transactions, allow holders to convert or put the notes at 100% plus accrued and unpaid interest. There is a possibility that the convertible notes remain outstanding in whole or partially if noteholders elect to retain their notes. Fitch assumes the convertible notes do not remain outstanding in its Base Case. In the event the notes remain outstanding, Fitch would treat them as 100% debt with no equity credit. The full balance would represent incremental pro forma leverage of 0.3x.

FULL LIST OF RATING ACTIONS

Fitch currently rates Expedia as follows:

Expedia, Inc.
--IDR 'BBB-', Outlook Stable;
--Senior unsecured bank credit facility 'BBB-';
--$500 million in 7.456% senior unsecured notes due 2018 'BBB-';
--$750 million in 5.95% senior unsecured notes due 2020 'BBB-';
--EUR650 million in 2.5% senior unsecured notes due 2022 'BBB-';
--$500 million in 4.5% senior unsecured notes due 2024 'BBB-'.