Online Travel's Narrowing Horizons


By Scott Kessler After some four months of waiting for both the Google (GOOG

; ranked hold; recent price: $108) IPO and our subsequent initiation of coverage on the shares to be completed, I, like many Americans this time of year, am thinking about one thing -- travel. So before I hit the road for my summer vacation, I think it's worth taking a look at the online-travel segment, which has had a fair share of news over the past month or so.

Interestingly, although many traditional travel-related companies have fared well in 2004 (except the airlines, which we believe are facing significant long-term issues), Internet travel companies have had a challenging year. For example, the S&P 1500 Hotels, Resorts, & Cruiselines index rose 10.7% year to date through Aug. 20. A number of gaming stocks we cover have also done quite well, thanks in great part to merger and acquisition activity, including Argosy Gaming (AGY

; accumulate; $32.50), Boyd Gaming (BYD

; hold; $26.85), Caesar's Entertainment (CZR

; hold; $15.20), Mandalay Resorts (MBG

; hold; $67.35), and Station Casinos (STN

; hold; $46.50), each of which rose 25% or more year to date through Aug. 24.

Contrarily, the online-travel companies we follow have fallen 6% on average this year through Aug. 24. IAC/InterActiveCorp (IACI

; hold; $24) fell 30% and Orbitz (ORBZ

; sell; $18.40) dropped 21%.

FADED FLOWERS. As the travel industry struggled after the September 11 terrorist attacks, reflecting weak demand and higher costs related to security, online-travel companies were able to capture market share and garner significant inventory that drove revenue growth and margin expansion. As a result, these outfits did quite well in 2002 and 2003. In fact, major online agencies such as Expedia, Hotels.com, and Travelocity were acquired during this time.

However, following a second-quarter preannouncement from Orbitz, mixed second-quarter results from Sabre Holdings (TSG

; hold; $23.40), disappointing second-quarter results and forward guidance from IAC, and what we see as a somewhat conservative third-quarter outlook from Priceline.com (PCLN

; accumulate; $21), it appears that the bloom is off the rose for the major online-travel companies.

Two problems have been plaguing the online-travel companies, in our opinion. First, they have access to considerably less inventory (notably, hotel rooms) than they had when times were tough in the travel business. With demand strong, travel vendors are retaining supply for direct sales. Making matters worse is increasing competition. There are more strong online players, which are spending considerably on solidifying their brands and marketing their messages.

NARROW MARGINS. In addition, the multi-year investments made by travel suppliers have been paying off, as these companies are employing the Internet to sell their offerings directly to consumers, travel agents, and businesses with much greater success. Lastly, online-travel search engines have started to emerge, such as those offered by QIXO and SideStep. In July, 2004, Yahoo! (YHOO

; Hold; $29) acquired travel search engine company FareChase.

What this means for online-travel companies, in our view, is that revenues will be harder to come by, and margins will be under pressure. The companies are pursuing growth by introducing new offerings and enhancing existing ones, spending more on advertising, expanding abroad, and going after corporate-travel customers. However, these endeavors require significant capital commitments.

In terms of stocks, we have hold recommendations on IAC and Sabre Holdings. We believe that although IAC faces challenges on many fronts, particularly with respect to its industry-leading travel business, the company is well diversified and reasonably valued.

Sabre's stock was hit this week following news that Northwest Airlines (NWAC

; hold; $9.25) plans to start charging fees on tickets distributed using Global Distribution Systems (GDS), including the company's Sabre GDS, but we believe the impact of this decision will be minimal. Not only do we not expect other airlines to follow suit, we aren't even sure Northwest will follow through on its decision. We believe the turnaround at Sabre has been completed, its Travelocity unit is gaining market share, and the stock is appropriately priced.

SINGLE PICK. In mid-August, we downgraded Orbitz to sell from hold. Orbitz is the youngest and smallest (based on market capitalization) of the four online-travel companies we cover, and we believe it will have the hardest time dealing with issues related to supply and competition. Existing partnerships could also prove problematic for the company. We expect its current relationship with Hotwire to expire later this month and competitor Priceline recently bought a majority stake in partner Travelweb. Also, Orbitz is majority owned by the major airlines, and given their tenuous financial footing, we believe selling the shares makes sense. Lastly, Orbitz trades at a premium to its peer group, based on price-earnings and p-e-to-growth ratios.

The only stock in the online-travel group that we recommend is Priceline, which we rank accumulate. We believe the company's efforts to build up a retail business have been successful, and will be emboldened by its recent acquisition of a majority stake in Travelweb. We also think the company's opaque "name your own price" business has become increasingly relevant as pricing for certain travel offerings (such as hotel rooms) continues to firm. The stock also trades at a discount to its peers based on p-e and p-e-to-growth ratios.

At this point, just as you would be very picky when choosing a vacation spot, investors should be selective when it comes to online-travel stocks.

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. (SPSI). An affiliate of SPSI received non-investment banking compensation from Argosy Gaming, Boyd Gaming, Caesar's Entertainment, Mandalay Resorts, Northwest Airlines, Station Casinos, and Yahoo during the past 12 months. Price charts and required disclosures for all STARS-ranked companies can be found at www.spsecurities.com Analyst Kessler follows Internet retail and Internet software and services stocks for Standard & Poor's Equity Research


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