Online Extra: Can Travelocity Fly Higher?

Although it's a turbulent time for the online travel industry, many analysts feel this company's stock is a good long-haul bet

On Nov. 12,'s home page featured two alarming alerts. One announced the temporary closure of JFK International airport after American Airlines flight 587 plunged into a New York neighborhood shortly after takeoff. Another notified visitors of the suspension in service by two airlines: Belgium's Sabena and Canada 3000.

The warnings were meant for travelers, but they could just have easily been for would-be investors in Travelocity -- No. 89 in BusinessWeek's latest update of the IT 100 -- and other online travel companies. Crashes, hijackings, a global economic slump -- it's a lot for an investor to consider.

GUT CHECK. Shares of Travelocity (TVLY ), which fell 9% just after the crash, have since recovered. But the stock remains about 47% off its high so far this year of $37.90 on May 24. Online travel stocks "are very risky," says Tom Underwood, an analyst at Legg Mason in Reston, Va. "Anytime you see demand for air travel diminish, it will impact the performance of these stocks." The effect is compounded in Travelocity's case because, in addition to peddling airline tickets, it lines up hotel rooms, rental cars, and cruises for travelers.

Even so, a number of analysts -- including Underwood, who has a buy rating on the stock -- believe the rewards of investing in Travelocity will outweigh the risks, especially if you have a strong enough stomach to hold onto the stock until the online travel industry has escaped the current turbulence. Launched in 1995, the company surprised Wall Street by recording its first profit in the first quarter of 2001. Analysts hadn't been expecting a profit until the end of this year.

In fact, few analysts of late haven't expected much of anything besides pornography to be profitable on the Net. "It is a long-term bet," says Paul Keung, an analyst at CIBC World Markets in New York, who also has a buy rating on the stock. "Near term, there is going to be a lot of volatility. The reason you are buying this stock is that online penetration rates [in the travel agency business] are going to grow."

COMPETITION. The online travel market is expected to expand 39% this year, to $20.2 billion in gross bookings, according to PhoCusWright in Sherman, Conn. That's a 12% drop from the forecast the Web travel consultancy issued prior to September 11. Travel expenditures represent about one-third of all spending over the Web.

Travelocity could be well positioned to capture a big chunk of those dollars in the future, analysts say. The company is the Net's travel-agency market leader with a 32% share, PhoCusWright says. "Our research shows that among the online travel agencies, Travelocity has the most consumer loyalty," says Lorraine Sileo, a PhoCusWright analyst. "However, the consumer will always go to where the lowest price is first and foremost. So if it isn't at Travelocity, they will go somewhere else."

That somewhere else could be Expedia (EXPE ), the Microsoft-backed online travel agency that's No. 2 on the Web, or Priceline (PCLN ), the name-your-price ticket seller popularized by former spokesman William Shatner. Comparing Travelocity and Expedia is like matching McDonald's against Burger King, says Krista Pappas, a New York-based senior vice-president for strategic development with, an Internet travel search engine for comparing prices and other options. "They both have good things about them," she says. "One might be better at cruises, and the other might be better at rental cars."

Underwood, who covers both stocks, says he rates only Travelocity a buy -- because of its valuation relative to gross bookings and gross profits. Travelocity's projected price-to-earnings ratio (or multiple) for the fiscal year 2001 is 51.9, compared with 90 for Priceline, according to earnings-tracking service First Call/Thomson Financial. "Relative to its value, I think Travelocity is attractive," Underwood says.

THE RESULTS. Ramesh Punwani, Travelocity's chief financial officer, says it's too early to tell what impact, if any, the American Airlines crash will have on his company's performance. He says Travelocity's bookings are running at about the same rate as before September 11 -- but about 80% of what they normally would be as the holiday season approaches.

Still, for the third quarter ended Sept. 30, the company posted a profit before special items of $4.9 million, or 9 cents a share, exceeding consensus estimates by a penny. Revenues rose to $78.5 million from $53.4 million in the year-ago quarter but were dampened by September 11.

Travelocity figures the terrorist attacks knocked at least $7 million off its revenues for the quarter, and it responded by eliminating 10% of its noncustomer-service staff. The company also plans to shutter a customer-service center. Travelocity, which is majority-owned by computerized travel-reservations company Sabre Holdings (TSG ), has said its fourth-quarter earnings will equal or exceed its third quarter results, and the consensus estimate among 11 analysts who cover the stock is a profit of 10 cents a share, according to First Call/Thomson Financial.

OUT OF COMMISSION? The uncertainties that could have an affect on the company next year go beyond safety and terrorism. Of all the online travel agencies, Travelocity depends the most on commissions from airlines, analysts say. When Continental Airlines (CAL ), the nation's No. 5 carrier, followed Northwest Airlines' lead and eliminated commissions to online travel agents on Oct. 24, Travelocity's stock was punished the most, dropping 29%. Commissions had run at 5% of each fare, to a maximum of $10. "We didn't see other airlines immediately follow, but eventually they will," says Sileo.

To protect its revenue, analysts say, Travelocity will have to work quickly to forge new agreements with airlines that will guarantee some kind of compensation for tickets sold. "The bottom line is, the airlines will want to work with agencies that perform for them," Keung says. "They are going to end up working it out with each other."

CFO Punwani says Travelocity has already initialed broad marketing pacts with a dozen airlines that ensure mutual benefits even if ticket commissions are no longer technically part of the relationship. Other types of fees and ads for the airlines on the Travelocity site are some of the chips in this trade. "It's a two-plus-two-equals-five arrangement," says Punwani. "The value that we get, and the value that the airline gets are both greater than before." When Travelocity sells tickets for Northwest, the only airline that it hasn't inked a deal with, it now requires passengers to pay a $10 surcharge to make up for the lost commission, Punwani says.

PROFIT SQUEEZE. Travelocity -- and all other travel agencies -n must also realize that the airlines themselves may continue to horn in on their business. The major carriers -- including American, Continental, Delta, Northwest, and Continental -- joined forces earlier this year to launch Orbitz, a Web site offering some discounted fares that are unavailable on other online travel sites. Orbitz has garnered attention for the quality of its search engine, but Travelocity and Expedia thus far remain the leaders in bookings. The Justice Dept. is monitoring Orbitz to make sure it doesn't develop an unfair advantage. "There is little that Orbitz can do pricewise that won't get the attention of Justice," Sileo says.

At least one skeptic thinks the Web sites of airlines, hotels, and other leisure companies will squeeze the profit margins of Travelocity and other online travel companies. David Neeleman, CEO of upstart airline JetBlue, made that prediction on Oct. 25 in an interview with BW Online (see The Airlines vs. Expedia and Travelocity). "The margins of online travel companies are already low," Neeleman said. "They could go rock bottom or disappear entirely. So I just don't see any growth in the business."

Punwani dismisses this gloomy scenario. As a first-mover, Travelocity has managed to build technology, a customer-service operation, and a client base of more than 30 million members, he says. He argues that sites run by individual airlines don't give travelers enough choice. And Orbitz has much higher unit costs, he says.

"We have put together a diverse revenue model," says Punwani, who notes that advertising, which represents about 19% of Travelocity's revenues, is expected to grow by 26% in 2001, to $60 million, at a time when most other online ad sales have gone south. (Some 70% of Travelocity's revenues come from sales of tickets and reservations, and the remaining 11% comes from charging fees for issuing printed tickets and the like). "Coupled with our scale and technology, that makes us by far the better economic model," Punwani asserts.

DIVERSITY. He concedes that Travelocity has been a latecomer in getting into higher-margin offerings such as cruises and package vacations. Nevertheless, he says the company is catching up fast. Currently, it derives about 68% of its transaction revenue from airline ticket sales, with the remaining 32% coming from car rentals and hotel bookings. Thanks to acquisitions, the company has added a robust selection of cruises, he says. "We're making a huge push to diversify our revenue stream," he adds.

Pappas says she's confident that Travelocity can become a full-service travel agency -- and thus enhance its staying power. Its vulnerabilities notwithstanding, it has plenty of cash -- about $107 million -- plus the backing of Sabre, one of the largest travel companies in the world. "I think they are on track to be one of the leading players in the industry," adds analyst Keung. Whatever the industry ends up looking like once it gets back to normal.

By Eric Wahlgren in New York

    Before it's here, it's on the Bloomberg Terminal.