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Three years after the dot-com bust, companies with loopy business models should not be going public. That may seem obvious, but the Aug. 28 initial public offering filing by online travel agency Orbitz Inc. makes it clear the point hasn't gotten through to everyone. It's bad enough that Orbitz, despite being on pace to sell $3 billion in travel this year, doesn't make money -- it lost $5.3 million in the first half of 2003 on revenue of $107 million. It's worse that Orbitz' revenues are growing only a little more than half as fast as those of rival and segment leader Expedia (EXPE
) Inc. Investors should avoid this deal, and Orbitz should pull it.
Orbitz' worst problem is straightforward: The five big airlines that own it, and will control its board even after an IPO, have forced Orbitz to underprice its services to subsidize themselves. And it's going to get worse. Commissions, mostly from owners United Airlines, American, Continental, Northwest Airlines, and Delta Air Lines (DAL
) provide 21% of Orbitz' revenue, among the biggest line items in its budget. But under the deal that created Orbitz, commission rates fall 27% in 2004, 28% in 2005, and 30% in 2006. That means the work that earns Orbitz a buck in commissions this year will get it about 37 cents in three years. Other online agencies don't disclose their airline deals, but they're known to take incentive payments for directing consumers to specific airlines. Orbitz doesn't. Why not? Because airlines hate paying those incentives. And the only top online agency willing to negotiate them away has been -- what do you know? -- Orbitz.
Orbitz has been too slow to figure out how to replace its commissions. For other travel Web sites, the big money is in merchant hotel sales and vacation packages. In both, travel agencies buy rooms and/or air tickets from suppliers, mark them up around 25%, and sell them at a profit. It beats the heck out of selling airline tickets for 3% or 4% commissions. Expedia gets 61% of revenue from merchant hotels and packages. Orbitz gets less than 15% of revenue from the same sources. Why? Orbitz CEO Jeffrey G. Katz has said lowering the cost of airline bookings is a higher priority. Sure -- for airlines.
Orbitz hopes to build a long-term advantage around the technology connecting its site directly to airlines' reservation systems. Dubbed "Supplier Link," it promises to cut out such middlemen as Sabre (TSG
), Worldspan, and Cendant (CD
) Galileo International (CD
) The middlemen charge about $13 per round trip. Meanwhile, Orbitz charges airlines a comparatively paltry $4 a ticket for the service. That saves the airlines $9 a shot.
Once again, that's great for the airlines -- and lousy for Orbitz, which eked out just $4 million in first-half revenue from Supplier Link. And even though no other online agency has the technology, Orbitz set the price of Supplier Link low to favor the carriers. It makes you wonder: Is Orbitz really set up to make money? And for whom?
The solution for Orbitz is obvious: The airlines should cut it loose and let it compete on an equal footing with its online rivals. Once it's not dominated by airlines, Orbitz will have a chance to thrive, cutting better carrier deals, focusing on the more lucrative hotel and package-tour business, and competing to please customers, not suppliers. Orbitz' technology is first-rate. Its management team is a lot brighter than the ideas Orbitz' ownership makes them defend. And Orbitz would still help airlines by competing with Expedia, whose market power threatens airline and hotel margins.
When you take a company public, you promise investors that you will fight to make them money. Orbitz isn't built for that. Until it is, this IPO should stay grounded. By Timothy J. Mullaney