Earlier today, news broke that Expedia , a popular online provider of travel products and services, was being downgraded by Deutsche Bank from buy to hold with a new price target of $51 as opposed to the $66 the bank previously estimated. The reason for this reduction was chalked up, primarily, to the fact that the company is being faced with more competition in its U.S. market and that changes in management for its Hotels.com business might impair the business in the short term. Understandably so, shares of the company fell more than 8% in response to the news, though they have recovered 1% of those losses since early this morning.

In a company in which most of its business is service oriented and in which there are little to no physical assets, threat of competition could serve to impair a company's future performance, thereby justifying a severe decline in share price (think AOL or, from a private company perspective, MySpace). But, with a company whose revenue has increased by 36.4% over the past four fiscal years, is there a possibility that the market is overreacting to its downgrade? In an attempt to answer this, let's begin by comparing its main competitor; priceline.com .

Earnings
From an earnings perspective, it's interesting to note that both companies have been relatively consistent, but in very different ways.


(table made by author with data derived from here)

As shown in the table above, Expedia has demonstrated a consistent decline in its net profit margin, while priceline.com has demonstrated pretty much the exact opposite. This news shouldn't bode well for shareholders of Expedia but, at the same time, investors should understand the origin of the company's declining net profit margin before they render a buy or sell judgment. Upon further analysis, it becomes clear that the company's primary driver for decreased profitability has been an increase in its selling, general and administrative (SG&A) expenses as a percentage of sales.

(table made by author with data derived from here)

According to the table above, Expedia has been seeing a significant increase in how much it spends for SG&A expenses. For instance, in 2009, the company spent 44.6% of its revenue on SG&A while in its most recent fiscal quarter, that number had risen to 56.6%. In juxtaposition, priceline.com spent only 46.8% of its revenue on SG&A expenses.

Breaking down these numbers a bit further, we see that Expedia has done a fairly good job at keeping these costs low from a general and administrative perspective (which has hovered around 8.5% to 9% of revenue for at least the past three years). However, its costs for garnering more attention on the web (its sales perspective) is mostly to blame for the rise in costs, which serves as an indication that Deutsche Bank is correct about the company facing more intense competition in the U.S. market.

Show me the cash, baby!
Though this information is valuable and should be considered by anyone interested in buying the company, there is another facet to consider: free cash flow. For a company lacking physical assets, free cash flow is an important indicator of success, perhaps more so than anything else.

(table made by author with data derived from here)

From a free cash flow perspective, we see something rather remarkable. Despite increased competition, both companies have rather attractive margins, while showing a steady increase in their ability to generate cash. For instance, Expedia has grown its free cash flow margin from 19.8% in 2009 to 24.7% in 2012 (a 24.7% increase). Likewise, priceline.com has seen its free cash flow increase from 21.2% in 2009 to 32.9% in 2012 (a 55.2% increase). Although both metrics are attractive, it would appear that priceline.com does, indeed, have a competitive edge, but it should be noted that Expedia is right on its coattails.

Foolish takeaway
Fundamentally, there is no question that priceline.com is superior to Expedia. On that basis alone, an investor should very much prefer investing in priceline.com as opposed to its smaller, struggling peer. However, the high margins and growth that priceline.com boasts comes with a high price. While shares of Expedia can be picked up for 6.3 times free cash flow, shares of priceline.com demand paying 29 times (using 2012's free cash flow per share, compared to today's price); a substantial premium. As always, Foolish investors should do their own research before making a firm commitment.

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The article Is Expedia a Buy After its 7% Decline? originally appeared on Fool.com.

Daniel Jones has no position in any stocks mentioned. The Motley Fool recommends Priceline.com. The Motley Fool owns shares of Priceline.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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