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USA-Expedia Deal Raises Valuation, Consolidation Issues

Yesterday's announced acquisition of Expedia by USA Networks threw a new twist into the soaring online travel sector.

First of all, it was a "takeunder," not a takeover, valuing shares of Expedia at about 20% under Friday's closing price of 48.70 a share. Estimates of the value of the complicated deal range from $35-$44 a share, with $40 the most-cited number. Expedia closed yesterday at $44.89. Stocks in the sector have had a nice run - Expedia is still up about 400% year-to-date - but a takeunder is a sure sign that someone either thinks the stock is overvalued, or they want out.

That someone, of course, is Microsoft , which will sell its 33.7 million shares in the company it founded to USA Networks . All told, USAI will acquire 37.5 million Expedia shares, or about 75% of the company.

Microsoft probably had a few motivations to do the deal. First, it has been moving out of the online content business for some time to focus on being, of all things, a software company. And second, Expedia is bleeding red ink, despite preannouncing better than expected pro forma earnings of 20-23 cents a share. On a GAAP accounting basis, Expedia is expected to lose 11-15 cents a share. Given that Microsoft is writing off just enough losses to post a GAAP profit of 1 cent a share this quarter, it probably needs to unload all the red ink it can. Also, Microsoft will pick up as much as $1.5 billion in the deal, a sizeable gain that could help offset any further investment losses.

But despite Microsoft's exit, the online travel business is soaring. Expedia and Travelocity , the top two sites, are growing revenues at triple-digit rates, benefiting from both the convenience of online travel reservations and consumers' desire to save money (although both should be keeping a watchful eye on Orbitz.com, a fast-growing industry site). Both stocks are expensive, trading at well over 100 times pro forma estimates for this year. But both stocks also have very nice uptrends going, with bullish 20-, 50- and 200-day moving average crossovers in April (see Expedia chart below). The chart of Expedia looks particularly good, but if the stock gives up its 20-day moving average (at 42.25 today), it could be the first sign that investors have doubts about the deal.

Analysts were upbeat about the USAI-EXPE combination, saying that USA Networks provides more distribution channels for Expedia, and investors so far seem to agree. USA plans to launch a travel channel selling vacation packages to viewers, using travel properties like Expedia and Hotel Reservations Network . There are two risks to that strategy. First, it's an ambitious effort for a slow-growth economy. And second, there is the risk that USA's online properties could be distracted from their main missions.

The online travel sector is a promising growth sector, but the USAI-EXPE deal is a sign that valuations may be high and that consolidation may just be getting started. In that uncertain environment, it might be a good idea to watch this one from the observation deck.