Priceline’s Kayak Deal Has Competitive Pitfalls, But Here’s Why It Makes Sense, Anyway
Analysts are applauding priceline.com’s (PCLN) decision to purchase online travel listing company Kayak Software (KYAK), citing global synergies. Even if rival travel agencies terminate meta-search contracts with the Norwalk, Conn.-based company, however, the $1.8 billion acquisition would prove just a blip in value lost for shareholders of the popular Name Your Own Price auction brand.
Either through its own website or mobile apps, Kayak enables travelers to easily compare and sort pricing information from dozens of travel-management websites at once, including airline tickets, car & vacation rentals, and hotel reservations. Under the merger agreement, Priceline will pay $500 million in cash plus $1.3 billion in stock, or about 37 times consensus 2013 earnings of $1.09 per share. A significant premium when compared with other online travel companies, including priceline.com.
"Strategically it makes sense," says Cowen Group (COWN) analyst Kevin Kopelman. “Kayak is strong in the U.S. but doesn't have the brand recognition internationally yet. And Priceline's booking.com brand is strong in Europe, but not in the U.S.”
More than 80% of Kayak’s revenue (split equally between third-party click-through ad sales and booking fees) is derived here at home; the reverse is true for Priceline, with about 82% of its sales (mostly booking fees) coming from international operations, according to recent regulatory filings. "So there is a potential for them to work together in a way that will help both companies," Kopelman says.
Unlike general search engine companies, Kayak focuses on a single market category – online travel. Management announced last week that the company processed 302 million queries across its website and mobile apps in the third quarter, a 31% increase from the prior year. This traffic growth, however, requires a significant outlay in online brand marketing: Fees (principally through the purchase of travel-related keywords) to Internet search engines like Google (GOOG) and Yahoo! (YHOO) and advertisement placements on other travel search services has eaten some 53% of total revenue in recent quarters.
The growing popularity of mobile platforms – revenue per thousand queries jumped 63% to $62 in the latest quarter – plus strategic expansion into car rental and hotel space (priceline.com booked 24.9 million days and 151.3 million room nights for the first nine months of 2012) should ease operating cost concerns going forward. Through September 2012, the company earned $19.8 million, or 48 cents per share, on year-on-year sales gain of 34% to $228.8 million. Analysts expect the merger to be accretive to earnings come 2013.
Wall Street, however, might want to revisit their earnings’ model: What would happen if rival travel firms abandon Kayak? In first-half 2012, Kayak derived 24%, 10%, and 9% of total sales, respectively, from deals with Expedia (Hotels.com, Hotwire), Priceline and Orbitz (including its CheapTickets and ebooker subsidiaries), according to regulatory filings.
“We don’t believe that our ownership of Kayak should dissuade other advertisers from participating,” said Priceline chief executive officer Jeffery Boyd.
As long as the advertising relationships remain “at arm’s length,” goes the conventional wisdom, travel suppliers won’t terminate their placement or query-results contracts with Kayak. Think again: Expedia (EXPE) exited the meta-search market, spinning off TripAdvisor (TRIP) in an IPO last year, when Priceline and Orbitz (OWW) balked at disclosing advertising budgets to Expedia.
It would be easy for any of Priceline’s competitors to walk away, too. Save for Orbitz, Kayak doesn’t have long-term contracts in place. Additionally, when it comes to airline reservation queries, Kayak licenses ITA Software (bought by Google in 2010), the same airfare and pricing system (called QPX) hosted by search rivals, like privately-held Mobissimo, TripAdvisor and TravelZoo (TZOO), general search engines, like Microsoft’s (MSFT) Bing, and airlines like American and United Continental (UAL).
Though Kayak is looking to move beyond the meta-search business, its business model is tethered to the “hunt.” In fact, the loss of any airline ticket search business would prove material to Kayak. The company derives 25% of sales from airfare searches. Moreover, management has previously stated in regulatory filings that “a significant number of travelers who use (our) websites and mobile applications for non-air travel services” come to Kayak first to conduct queries on airline ticket pricing information.
Nonetheless, that which is material to Kayak is immaterial to Priceline: The online travel behemoth has a good track record of absorbing and growing its acquisitions – and with a market capitalization of $31 billion and levered free cash flow of $1.25 billion, it can easily pay for the Kayak purchase.
Furthermore, even if the acquisition proves disruptive to Priceline, it’s going to take more than a “kayak tipping over” to drown consensus FY 2013 estimates of $37.31 per share.
The bigger threat to Priceline down the road is whether or not the likes of Apple or Google can gain traction in online travel, especially with mobile users.
David J. Phillips is a contributing editor at YCharts, which includes the just-released YCharts Pro Platinum for professional investors.