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STREET WISE By Amey Stone April 29, 1999


Why Priceline.com Could Be the Net's Next Superstar
Even with its post-IPO runup ($16 to $121 now), analysts are gaga over its business model and prospects

While a flood of initial public offerings has broadened the ranks of Internet stocks this year, top-tier Internet names have shrunk to just a handful. America Online (AOL), Yahoo! (YHOO), eBay (EBAY), and Amazon.com (AMZN) arguably capture the lion's share of the headlines -- and the capital. But now a new entrant may be on its way to the vaunted status of Internet superstar.

That company is Priceline.com (PCLN), which operates a sort of reverse auction in which customers name their own price for airline tickets, hotel rooms, home loans, and other products and services. In business only a year and publicly traded for one month, Priceline has already gained top billing from several of Wall Street's most influential Internet analysts, who initiated coverage once the 25-day waiting period following the IPO expired on Apr. 26.

MORE POTENTIAL THAN PAYOFF. Merrill Lynch analyst Henry Blodget wrote in an Apr. 27 report: "Our basic Internet investment philosophy is to own a basket of industry leaders -- and this looks like one of them." BancBoston Robertson Stephens analyst Keith Benjamin wrote on Apr. 26: "In our view, Priceline.com's business model lends itself to being one of the most successful we've ever seen." Morgan Stanley Dean Witter's Mary Meeker set an outperform rating on Apr. 26 and credited Priceline with "strong brand name, first-mover advantage, and unique business model."

Not surprisingly, after such comments, the stock took off. Offered on Mar. 29 at a mere $16 a share, it soared to a high of $140 a share on Apr. 27, before falling back a bit to close on Apr. 28 at $121.

 

With its patented bidding system, Priceline might "transform" E-commerce, says Warburg's Zeilstra
 

Typical for the Internet sector, Priceline's new status is due more to its potential than solid results. Founder Jay Walker's big idea was to use the Internet to allow consumers to name their price for all sorts of goods and services. Participating sellers decide which prices they will accept, and Priceline makes money either off the spread between what it pays the seller and what it charges the consumer (for airline tickets) or from a fee paid by the seller (for autos). It's an E-commerce business model so unique that Priceline actually patented it.

"We think the company is well-positioned to really transform the way commerce takes place over the Internet," says Sara Zeilstra, an analyst with Warburg Dillon Read. From only $35 million in revenues in 1998 (the site launched in April that year), 1999 revenues are expected to reach around $200 million. "That's phenomenal growth," Zeilstra says.

BUILDING UP SUPPLY. In its first year, Priceline says 1 million people tried the service, and it is now averaging 300,000 new customers a quarter. It sells an average of 20,000 airline tickets and 5,000 hotel-room nights a week at current rates. And it facilitated the approval of $125 million in loans in its first 90 days in the home-lending business. While there are plenty of other travel and personal finance sites out there, "Priceline's advantage is that it can allow sellers to fill multiple orders at different prices at the same time without disrupting established retail prices or current distribution channels," Benjamin wrote in his recent report.

Yet one of the company's challenges has been to build enough supply to meet demand. Priceline was criticized early on for being able to fill just a small percentage of airline bids, but it has increased participating airlines from five at the start to 18 now. The company says it can now fill 35% of reasonable requests (those not more than 30% below lowest available advance-purchase fares), up from 24% two months ago. On popular routes, it can full up to 73% of reasonable bids.

MAJOR NEW OFFERINGS? Priceline plans to expand its offerings along four major product lines -- travel, financial services, automotive, and retail. Home insurance, all-inclusive resorts stays, consumer electronics, and life insurance are a few of the upcoming possibilities. "This is really a platform that can be utilized for selling nearly anything over the Internet," says Zeilstra.

That's all well and good, but what about the kind of results that investors usually care about -- profits margins and earnings? It's far from proven that Priceline can make money at its business. In 1998, its net loss was $112 million, or $1.41 per share. It actually operated at negative gross margins (which means it sold airline tickets for less than it paid) when it launched, although Benjamin estimates the average margin on airline sales is around 5% and could grow to 12% as volumes increase. Benjamin is projecting that Priceline can increase revenues at a rate of 70% a year from current businesses alone and will break even in 2001 on revenues of $525 million.

While analysts have high hopes for Priceline, some reports did not ignore the fact that the stock has already moved into the stratosphere. From its initial offering price of $16 on Mar. 29, Priceline shares were trading around $88 when Meeker's report was released on Apr. 26. Noting that the stock had already gained 450% in a month, Meeker wrote: "Are we nervous about PCLN's valuation? You bet. However, again, for risk-oriented investors, the risk of missing a big winner here may be greater than suffering from what may become near-term valuation issues."

 

Aside from the high valuation, perhaps the biggest risk is the chance of a slipup in execution
 

Blodget released his report the following morning, when the price was already above $12, and called the stock's valuation "eye-popping." He wrote: "Because of the magnitude of the opportunity, however, as well as the company's recent revenue trajectory, we think there is 12-month upside from here." He set a 12- to 18-month price target of $150. "Part of the problem is that we have so little history on which to base projections," says Blodget, who says he is not particularly concerned about Priceline's valuation.

Zeilstra set a price target of $115 when she initiated coverage and won't change it until she gets a look at first-quarter results on May 4. She expects Priceline to report a loss of $18 million, or 13 cents a share, on revenues of $44.5 million. Notes Meeker: "There is valuation risk here, and it will be critical for PCLN to execute above plan."

There are plenty of other risks, to be sure. Another entrepreneur could come up with an even more compelling E-commerce business model, or Priceline's patent could prove vulnerable. Blodget believes Priceline's status as the first and the largest is more important for fending off competition than the patent. And, of course, the rapidly growing company could slip up. "The biggest risk ahead is execution risk," says Zeilstra.

Wit Capital's Jonathan H. Cohen suggests that investors buy the stock on any weakness. That sounds like good advice, especially since the Internet sector usually slides after earnings season, which is wrapping up in the next week or two. It may be true that for some Internet investors, the risk of missing all the opportunity in owning Priceline is greater than the downside risks. But most investors should probably wait to see more proof that Priceline really can live up to its early potential before bidding for its shares.

Amey Stone is an associate editor of Business Week Online


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Amey Stone covers the markets and investing for Business Week Online




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