Web Travel Agencies: A Bumpy Ride
By Scott Kessler
Despite the dot-com bubble's bursting and the travel industry's near-derailment in the past few years, online travel companies have shown surprising resiliency. We at Standard & Poor's Equity Research Services believe that most large Internet travel businesses have actually prospered since 1999. This success largely reflects the undeniable trend that more consumers and businesses are increasingly buying trips on the Web. According to online travel research firm PhoCusWright, the Internet will account for about $50 billion in U.S. travel bookings in 2003.
With the economy on the mend, demand for travel services increasing, and investors still interested in Internet stocks, we think outfits with significant online travel businesses should fare quite well in 2004. The recent IPO of Chinese travel company Ctrip.com (CTRP ) and anticipated public offering of Orbitz (which we expect to debut as early as the week of Dec. 15) suggest that industry participants believe better times are ahead.
Still, we think the online travel agencies face their fair share of challenges. One worry is what we perceive as an increasing strain on relationships with suppliers, as evidenced by US Airways' recent decision to remove its flight listings from Expedia.com.
Greater demand for travel services, coupled with capacity that has grown modestly at best, has also led to less inventory for the online travel distributors. This supply-and-demand situation is favorable for the airlines, hoteliers, rental-car companies, and cruise liners and is perhaps causing them to revisit some of their distribution contracts.
The suppliers are also strongly committed to price consistency across all distribution channels. To promote this "price integrity," as it's called in the industry, many hotel chains, for example, offer rate guarantees that provide discounts if lower rates are found via third parties. The suppliers' goal is to regain control over the pricing of their inventory and, ultimately, to improve relationships with customers to generate greater brand loyalty.
Because the travel sites are low-cost customer-acquisition vehicles for the suppliers and can provide instant demand for inventory, they're still important partners. However, we believe that only the distribution relationships that provide significant value to suppliers are going to be insulated from reassessments.
FOCUS ON LOYALTY.
Another concern is mounting competition. The dot-com shakeout and industry consolidation have reduced the number of online travel businesses, but several well-established players remain. Moreover, traditional companies continue to develop and deploy increasingly sophisticated Web sites offering expansive inventory from themselves and other suppliers, advanced-search capabilities, and value-added content.
Interestingly, a recent Web seminar conducted by PhoCusWright and market researcher Vividence indicated that although online travel agencies have the most flexible Web sites, supplier sites rated best in terms of overall customer satisfaction and likelihood to purchase.
We believe the agencies also could be vulnerable as suppliers increasingly focus on garnering customer loyalty. Preserving or restoring price integrity is part of this, in that it promotes greater trust and interaction directly with suppliers. Another way suppliers promote direct customer relationships is by giving consumers loyalty-program credit only if they make purchases directly from them.
Suppliers are working to learn more about their customers to provide more personalized communications and experiences. Harrah's Entertainment (HET ) has taken this notion to an extremely high level, in our view, by employing "decision science" (gathering and analyzing data about its customers' traveling and spending habits for predictive purposes) to stimulate property visits and spending. Some 70% of the Harrah's rooms are used by its Total Rewards members.
The online agencies are also starting to make inroads in corporate travel, after years of planning and investment. In November, Orbitz announced that it won McDonald's (MCD ) as a corporate travel customer. The traditional players in corporate travel, such as American Express (AXP ), have been preparing for such competition by Web-enabling their businesses and bolstering service offerings. However, we expect the online agencies to win their fair share of corporate customers because of their recognized brands, easy-to-use Web sites, and cost advantages.
Notwithstanding worries related to the suppliers and competition, we believe investment opportunities exist in the online travel segment. Our favorite is InterActiveCorp (IACI ; recent price: $30), which owns Expedia, Hotels.com, and "opaque" travel site Hotwire.com (where all of the specifics associated with a particular purchase aren't disclosed until the transaction is consummated).
The shares have been weak following somewhat disappointing third-quarter results, and because of the above-described concerns, but we believe company fundamentals are intact, and the stock is an attractive value. We think InterActive's multiple brands and market leadership will enable it to continue to fare well compared with its competitors.
PRICELINE: A TARGET?
InterActive stock trades at a significant discount to our 12-month target price of $40, which was derived using discounted cash-flow analysis (with assumptions that include a weighted average cost of capital of 13% and average annual free-cash-flow growth of 23% over the next five years). The shares also have a 2004 price-earnings-to-growth (PEG) ratio of 1, which compares quite favorably with its peers (1.7) and the S&P 500 (1.4).
We have a hold recommendation on both priceline.com (PCLN ; $17) and Sabre Holdings (TSG ; $20). We believe that despite the struggles of priceline.com's opaque airline-tickets business, it has been diversifying into hotel reservations, vacation packages, and various retail offerings through its Lowestfare.com subsidiary. With IAC's recent purchase of Hotwire.com, priceline.com could be an acquisition target.
Sabre Holdings has several travel-related business segments, including Travelocity, the second-largest online travel agency based on gross bookings. Sabre has been restructuring to improve its focus and cut costs, and we believe the recent appointment of new CEO Sam Gilliland (the former head of Travelocity) signals that growth will become a more important priority in 2004. Despite turnaround potential, the shares trade at a premium to the S&P 500 based upon p-e and PEG ratios.
Although the online travel agencies have been riding a wave of surging Internet usage, we don't expect a rising tide to lift all boats. Our bet is on the outfit that we believe is the best situated competitively -- InterActiveCorp.
Note: Scott Kessler has no stock ownership or financial interest in any of the companies in his coverage area. He's a registered representative of Standard & Poor's Securities, Inc. Other S&P affiliates may provide services to the companies under discussion.
Analyst Kessler follows Internet software and services and Internet retail stocks for Standard & Poor's Equity Research Services
Edited by Karyn McCormack