Adherence to new policy removes overhang. Ctrip offers Chinese travellers thelargest selection of products and a range of value-added services (VAS such asinsurance) are offered on an “opt-out” basis. In response to regulation, VAS will beoffered on an “opt-in” basis. We estimate that VAS is 10-15% of total net revenue and30-40% of operating and net profits. It is testing opt-in with select customers currentlyand many customers continue to purchase VAS. It is also considering new products tomitigate any negative impact and potentially offering a membership fee (similar toAmazon Prime) for VAS. That said, given the uncertainty, we cut our revenue andearnings estimates to reflect this policy adjustment. We expect Ctrip to remain thecategory killer in China travel, with over 65% market share in online travel and we expectgrowth and margin expansion to continue following this reset. In particular, Ctrip’s growthis tied to outbound international travel and rising demand from low-tier cities.    2Q results beat expectations. Net revenue grew 45% y-o-y to RMB6.4bn, withaccommodation revenue up 30% y-o-y, transportation ticketing up 49% y-o-y,package tour up 29% y-o-y and corporate travel up 36%. Adjusted OPM wasparticularly strong at 18%, versus 4% a year ago, and our estimate of 15%, due tohigher-than-expected gross margins and lower S&M. Adjusted EPS was USD0.22,28% higher than our estimate. Domestic hotel coverage grew 25% y-o-y to 570k.Similar to Priceline, Ctrip believes vacation home rentals will rise in popularity, and itnow has 450k vacation rental properties available, with bookings up over 100% y-o-y.In lower cities, it has 400franchised retail stores (and 5,500franchised TravelingBestone stores) and traffic from T2cities grew 50% from a year ago. Skyscannerexperienced a 50% increase in conversions with its “direct booking” feature. 40% ofservice inquiries are handled by AI-chat bots currently. Management expects 3Qrevenue to grow 35-40%, in-line with consensus, and adjusted OPM of 20%.    Estimate changes. We cut our revenue and EPS estimates to reflect lower VAS anda higher tax rate. For 2017/2018, we trim revenue by 3/8% and lower EPS by 31/47%respectively. For 2017/2018, we expect net revenue to grow 37/22% and adjustedOPM of 17/19%, reaching 26% by 2020. Management continues to expect OPM toreach 20-30% in the next 1to 2years.    Maintain Buy and cut our DCF-based TP to USD56from USD62. Our Buy thesisrests on three points. First, we believe Ctrip’s scale and product breadth representsignificant barriers to entry. Second, international expansion and growing demand fromlow-tier cities will provide long-term growth opportunities. Third, we expect materialmargin improvement over the next few years due to rising scale and efficiencies.

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