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Here's What Matters For Priceline's $590 Valuation

By: Trefis
Posted: 1/7/2013 1:04:00 PM
Referenced Stocks: EXPE;KYAK;OWW;PCLN;TRIP

Priceline ( PCLN ), a leading online travel agency (OTA), provides its customers a broad range of travel products and services such as hotel bookings, airline tickets, car rentals, cruises and vacation packages. It operates online travel portals - priceline.com, booking.com, agoda.com, rentalscars.com, breezenet.com and lowestfares.com - that connect travelers with travel suppliers around the world. Priceline recently announced its acquisition of Kayak, a leading travel search company, which marks its entry into the meta-search space.

Our price estimate of $584 for Priceline marks our valuation at a slight discount to the current market price. While we maintain a positive outlook for Priceline's long-term growth prospects, we think the current growth rate is difficult to sustain in the long run. (Read: Why We Think Priceline Is Fully Valued At $590 )

In this article we provide a snapshot of how Priceline makes money and the important segments that contribute to its growth.

See our complete analysis for Priceline

Who are Priceline's customers? How does the company make money?

Priceline simplifies its users' travel search by providing them easy access to booking details of airlines, hotels, cruises and car rental packages on a single platform. Its customers include users looking for travel products/deals for leisure as well as for business purposes. Priceline's customer base also covers travel products and services suppliers who advertise on its websites.

Priceline enables its customers to purchase travel services under the traditional price disclosed model and/or via the opaque pricing model. Under the traditional price disclosed model, the company earns a commission on every transaction made on its website. While under the opaque pricing model, users bid for services at discounted prices and Priceline earns the difference between the price an individual is willing to pay and the price charged by the travel service provider. In addition, the company makes money from advertisements placed on its websites.

Important segments that contribute to Priceline's Growth

Priceline has witnessed a strong double digit growth in its top-line since 2008. The company made $4.4 billion in revenue in 2011 and earned 35% operating profit, which is constant across its business segments. An expanding footprint in international markets and rapid innovation has helped Priceline witness growth across its businesses.

We expect Priceline to continue growing in the future, albeit at a slower pace. While there are immense growth opportunities, especially in international markets, we feel the intense competition from other OTAs and leading search engines will restrict Priceline's growth in the future.

We also estimate operating margins to remain range bound over our review period. The online travel services is a highly competitive niche segment. In an effort to gain a competitive advantage, travel companies are creating new promotions and consumer value features such as eliminating processing fees, waiving cancellation and change fees, etc. Thus, we feel that the intense price competition will restrict growth in operating margins.

1. Hotels

Accounting for 97% of Priceline's revenue and contributing around 83% to its total gross booking, hotel bookings is the most important division in Priceline's portfolio. Hotel bookings offer around 23% revenue margin which also makes it the most profitable division compared to airlines (3%) and car rentals & cruises (9%).

We consider this business to be of strategic importance for Priceline's future and believe the company has fared well so far to leverage growth not only in the US but in international markets as well. We estimate Priceline's revenue and gross bookings from hotels to increase in the future.

Priceline has been focused on expanding its international footprint. While Booking.com is concentrated in Europe, Agoda.com is focused on Asian markets. Currently, Booking.com has over 245,000 hotels and other accommodations, a 44% increase from last year. Additionally, Agoda is significantly building scale in Asia-Pacific and is also witnessing strong room night growth.

However, we forecast a gradual decline in commission earned by Priceline on hotel bookings. International operations of Priceline sell hotel reservations primarily under the agency model in which net revenues are generated in the form of commissions and bookings fees, resulting in lower revenue margins. In the US, Priceline operates primarily under the merchant model, where the users bid for services and the booking is completed on Priceline's website itself. The merchant model offers scope for charging higher margins.

Additionally, expansion in the Asia-Pacific region could lower the average revenue per room for Priceline. Growing competition from hotels directly selling their inventory online and intense competition from other OTAs in the market would also drive down booking fees and commission for Priceline.

2. Airlines

While airline tickets contribute close to 15% to Priceline's gross bookings, it accounts for only 1.7% of the company's revenue. The airline industry is perhaps the most competitive of all travel products. It has been suffering from chronic overcapacity leading to lower occupancy rates. This coupled with high volatility in fuel prices has led to structural changes in the aviation industry.

Additionally, airlines are increasingly selling tickets online directly from their own websites, thereby eliminating the need for online travel agents. As a result, online travel service providers have been compelled to remove processing fees on air ticket bookings and the cancellation and rescheduling of fees in excess of that charged by the airline itself.

Nevertheless, booking an airline ticket remains an integral part of the entire travel plan. OTAs still continue with air ticket bookings since they are able to sell other services such as hotel room bookings, car rentals, cruises, etc. on which they stand to make higher revenue margins.

Amid rising competition and squeezing revenue margins, the bigger players, such as Priceline, have a better chance of survival since they are better placed in bundling different products into holiday packages and offering complementary destination services to gain traffic. In addition, under the merchant model, the bigger players can draw better discounts from suppliers on account of bulk bookings.

3. Cruises & Car Rentals

Cruises and car rental services contribute 1% and 2% to Priceline's revenue and gross bookings, respectively. Cruises and car rental services have historically been clubbed together with destination services and offered complementary as part of holiday packages. However, with rising bookings recently, there has been an emergence of cruises as a separate travel product. Thus, going forward, we estimate a marginal increase in revenue from cruise bookings and car rental services.

Priceline currently earns around 9% booking commission on these travel products. Unlike other travel products which are mostly purchased stand-alone, cruises are mostly purchased under bundled packages such as holiday packages and as a value-added service offered complementary to other products. This leaves scope for charging higher revenue margins by the online travel agencies.

4. Advertising

Priceline earns only 0.3% of its revenue from advertising fees. We do not expect the percentage contribution to be any different in the future. However, as the macro conditions stabilize and the user traffic on Priceline's website continues to increase with expanding international presence, we forecast a steady growth in its advertising revenue.

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