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Online Travel: All Over the Map

By Scott H. Kessler It's mid-January, and I'm thinking about travel. That news probably isn't surprising, given that it has been mostly cold and dark outside since Thanksgiving. Alas, right now, I'm not thinking about taking an actual vacation -- although that sure sounds nice. Instead, I'm thinking about the business of travel, and online travel in particular. Also, I'm thinking that the online travel agencies and their owners are going to have a tough time in 2005, particularly Sabre Holdings (TSG

: S&P Rating: Hold; share price: $20), which owns Travelocity.

In our opinion at Standard & Poor's, 2004 was hardly a banner year for online travel companies and their shares. The three stocks we cover in the segment, IAC/InterActiveCorp (IACI

: Hold; $25), (PCLN

: Buy; $24), and Sabre all fell significantly from their 2004 highs. They also underperformed both Internet and leisure-company stock indexes. On average, these three stocks rose only 5.7% in 2004, while the S&P 1500 Internet Retail Sub-Industry Index surged 80%, the Internet Software & Services Index advanced 59.6%, and the Hotels, Resorts & Cruiselines Index climbed 45.4%. Heck, even the S&P 500-stock index was up 9%.

FEWER ROOMS. Moreover, in 2004 the online travel outfits often provided quarterly results and forward guidance below our forecasts. Management changes have been occurring regularly throughout the industry, and it has been difficult to keep track of them all. Intense, ever-mounting competition and reduced access to inventory remain notable concerns, in our view.

At S&P we believe the most significant issue for Internet travel agencies is competition. There are a number of established segment players: Cheap Tickets, Expedia,,, Orbitz,, and Travelocity come to mind. We expect Orbitz to be a more formidable competitor following its November, 2004, acquisition by Cendant (CD

: Hold; $22).

In our opinion, Expedia and its sister businesses, and Hotwire, should be emboldened by their pending spin-off (under the Expedia moniker) from IAC. Pending necessary approvals, we expect that to happen around March, 2005.

LATEST ARRIVALS. Not surprisingly, the travel suppliers -- airlines and hoteliers, for example -- are increasingly focused on the Internet as a channel for sales, marketing, and customer communications and service, continuing to invest heavily in their Web sites. Travel-search services such as those provided by FareChase, Kayak Software, Mobissimo, QIXO, and SideStep, which are often referred to as "metasearch" offerings, are becoming increasingly popular.

Also, major Internet players are getting more involved in travel. FareChase was acquired by Yahoo (YHOO

: Buy; $36) in July, 2004, and Kayak announced AOL as a minority investor in November, 2004. In addition, more traditional travel giants such as American Express (AXP

: Hold; $53) are becoming increasingly active online. Emerging players such as G2 Switchworks and ITA Software are working on technologies that we believe will promote even greater competition.

Clearly, as companies pursue what JupiterResearch predicts will be $62 billion in U.S. online travel booking revenues in 2005, the segment is pretty crowded.

BOUGHT AND BEEFED-UP. However, despite significant anticipated market-share gains from off-line players, JupiterResearch forecasts only 10% average annual growth from 2005 to 2009. And we believe competition will have a negative impact on profit margins. In early 2004, a number of online travel agencies made pricey, multichannel marketing pushes featuring characters from William Shatner to the Roaming Gnome. We expect more of the same in 2005.

There has been significant industry consolidation over the past 18 months. But even though Expedia,, Hotwire, and Orbitz have been acquired, all remain important and aggressive industry participants, in our opinion. Ironically, we believe these services have actually become more competitive following their acquisitions, as they now have the greater resources of parent companies to tap.

Much of these resources are being deployed to expand internationally, and consolidation and competition are really heating up abroad.

GLOBAL REACH. In November, 2004, Cendant acquired ebookers, a leading European online travel agency. In December, 2004, Cendant announced the proposed acquisition of two more significant British-based Internet travel businesses, whose purchase we expect to be completed by April, 2005, pending necessary approvals. In October, 2004, Sabre consolidated ownership of its Travelocity Europe joint venture. The month before, acquired Active Hotels, a European provider of online hotel reservations.

Interestingly, as competition has grown more intense, travel suppliers have provided less inventory to online travel agencies. A few years ago, when times were tough and people weren't traveling as much, hotel chains needed help. That's where the Internet travel companies came in. They bought inventory in bulk and used their marketing muscle to sell rooms. This merchant model was great for online travel agencies.

However, as travel demand improved, hotel companies have taken greater control of their inventories and directed would-be purchasers to their own Web sites, which are now quite good and increasingly focused on customer loyalty, in our opinion. Would-be travelers often search third-party travel Web sites to obtain information and comparison shop, but make their actual purchases via supplier sites.

Travel-search services have largely sprung from this behavior, enabling users to engage in searches of agency and supplier offerings and go directly to the Web sites of their choice, often of the suppliers.

DULLER EDGE? With better-known brands and offers of loyalty benefits, we believe the travel suppliers pose a substantial threat to the online travel agencies. Remember, you can't always get so-called frequent-flier miles when booking on Expedia, Orbitz, or Travelocity. Moreover, we expect suppliers to promote their Web sites more aggressively through mass marketing, targeted advertising, and personalized incentives. We also expect travel-search services to gain momentum and capture material traffic and transactions from the Internet agencies.

Based largely on this challenging outlook, we have a hold recommendation on Sabre. We previously carried a sell opinion on the stock, but upgraded the shares on Jan. 7, following a 12% decline since early December, 2004. We believe Sabre faces substantial competition and will deliver growth in earnings that will disappoint some.

We see Sabre's current cash cow, its global distribution system (GDS), as likely to experience pricing pressure and margin erosion. Longer term, we believe companies such as G2 and ITA could render the GDS business, which accounted for 71% of Sabre's third-quarter adjusted total revenues, largely irrelevant.

EARNINGS DISAPPOINTMENT. Travelocity has had a pretty good 2004, in our view. Adjusted revenues for the first nine months of the year rose 30%. A new brand image and advertising campaign helped deliver market-share gains, a revised and extended marketing arrangement with AOL resulted in cost savings, and the acquisitions of its Travelocity Europe joint-venture and SynXis, a provider of reservation systems for hotels and casinos, made strategic sense to us.

However, we believe 2005 will be a different story. Comparisons will be tougher. The acquisitions will likely consume resources and management's attention. In December, 2004, Sabre said it expected 2005 earnings per share to increase only 5%, below our prior double-digit forecast, owing in large part to new business initiatives. In addition, the important exclusivity agreement with Yahoo is set to expire in December, 2005.

Sabre does have a healthy balance sheet consisting of $474 in net cash and investments, as of September, 2004. We believe it will deploy at least some of this capital to continue making acquisitions to bolster its competitive positioning and spur growth.

ROCKY ROADS. In particular, we think the purchase of would make sense for Sabre. One of the reasons for our buy recommendation on priceline is because of the outfit's acquisition potential. Nonetheless, we are generally skeptical of growth strategies predicated on acquisitions.

We believe the world of online travel is growing increasingly challenging for the major agencies and their parents. While this bodes well for consumers and perhaps for suppliers, we foresee trouble ahead, particularly for Sabre, the parent of Travelocity.

For many in this sector, 2005 will be a year to forget -- even before it really starts. Kessler is Internet Software & Services and Internet Retail Equity Analyst at Standard & Poor's

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