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Investment Overview for Kayak (NASDAQ:KYAK)
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Air Ticket Queries On Kayak:
In 2011, Kayak received 754 million air ticket queries on its website. We estimate the figure to rise up to 2.8 billion by 2019. However, post ITA's acquisition by Google, if Kayak's contract with ITA Software does not get renewed or does so at unfavorable terms, our estimates could turn out to be too optimistic. If the number of air queried only reached 2 billion by the end of 2019, we could see a 16% decline in our price estimate.
Online Ad Revenue Per 1,000 Queries:We currently forecast Kayaks online ad revenue to go up to $268 per 1,000 queries by the end of our forecast period. However, there would be a 12% downside to our price estimate if the ad revenue per 1,000 queries increases to only $200. On the other hand, if the revenue rises to $320 per 1,000 queries, there will be a 10% upside to our price estimate.
Hotel Referral Fees Per 1,000 Hotel Queries: We estimate the referral fees per 1,000 hotel queries to increase to $583 by 2019 from the current level of $267 per 1,000 queries. However, in the likely scenario of the referral fee remaining at a constant level for the rest of our review period, there would be a 10% downside to our price estimate.
Kayak's EBIDTA Margin: We currently forecast Kayak's EBITDA margin, which currently stand at 15.7% to go up to 25% by 2019. However, if the revenue margins remain in the 18-20% range, then we would see a greater than 10% downside to our price estimate.
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Kayak is a travel search company. Kayak’s website and mobile applications facilitate easy research and comparison of fares and other travel related information collected from hundreds of travel websites (both supplier websites and online travel agencies’ websites).
Kayak provides travel buyers a one-stop research solution to best fares along with travel management tools and services such as flight status updates, pricing alerts and itinerary management. Once users select a flight, hotel or other travel product, Kayak directs them to the travel supplier (airline website or hotel website) or an online travel agency to complete the purchase. In some cases, users can complete the booking without leaving the Kayak website altogether.
Kayak’s services are free for travelers. It earns two streams of revenues: (i) revenues from referrals to travel suppliers and OTAs, also known as Distribution Revenues, and (ii) ad revenues from advertising placements on its websites and mobile applications.
While Kayak complements online travel agencies by directing the online traveler to their websites (should he select the fare quoted by that online travel agency) earning Distribution Revenue in the process, it also competes with the online travel agencies for advertising placements on its websites.
Kayak is a technology-driven company founded in 2004 by the co-founders of Expedia, Travelocity and Orbitz. In addition to the strength of the management team, the investors include some of the most prominent venture capital and private equity firms, including Sequoia Capital, Accel Partners, General Catalyst Partners and Oak Investment Partners. As of June 2012, Kayak had 185 employees and local websites in 15 countries outside the US, including the UK, Germany, France, Spain, Italy and India.
GOOGLE POTENTIAL CRUCIAL THREAT TO KAYAK'S BUSINESS
In July of 2010, Google announced an agreement to acquire ITA Software. ITA licenses its airfare search and pricing software to Kayak, under an agreement which expires in December 2013. The faring software currently accounts for 39% of Kayak's overall airfare query results. Airline travel queries account for close to 85% of total searches performed on Kayak's websites and mobile applications.
Post the regulatory approval of the acquisition in April 2011, Google has created its own flight search tool which enables people to find comparable flight information on the internet without using Kayak's services. In addition, Google may not renew ITA's current agreements with the online travel agencies and the likes of Kayak or do so at unfavorable terms. Kayak admits that it is unable to replace ITA with a comparable technology. Hence a loss of access to ITA's software could have a significant adverse impact on the comprehensiveness of query results and consequently on the revenues and operating margins of Kayak.
For additional details, see Facts about Google's acquisition of ITA Software.${header:sourcesofvalue}
Advertising is the leading source of value for Kayak due to:
Higher distribution revenue per query than referral revenue per query
We estimate that Kayak earns over $160 in ad revenue for every 1,000 airline ticket, hotel, car rental or cruise query that occurs on Kayak's site. In comparison, we estimate that Kayak earns only about $61 in referral revenue for every 1,000 airline ticket query on its site and airline queries account for the bulk of queries - about 754 million of an estimated 899 million total queries in 2011.
Hotel referrals are a more important source of value for Kayak than airline or car rental referrals for the following reason:
Referral revenue per query for hotels is four times higher than referral revenue per query for airline tickets
Although Kayak processed an estimated 754 million airline ticket queries in 2011, the company earned about $81 per 1,000 queries in airline tickets. In comparison, the company processed only about 117 million hotel booking queries, but earned about 2x more or about $267 per 1,000 hotel booking queries. Furthermore, we expect this ratio to increase as hotel referral revenue increases, while airline ticket referral revenues decrease per 1,000 queries.
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The outlook for Kayak depends on the performance of the travel industry as a whole. However, given the rise in competition among online travel agencies, travelers have been spending more time in searching for ‘best fares’ online. Kayak addresses this core consumer need by collating fares across the internet, thereby offering greater convenience to the online traveler.
The following factors determine the fate of online travel industry
Macroeconomic environment impacts travel demand & travel advertising
Due to the discretionary nature of leisure travel, online travel service providers, which earn revenue in the proportion to travel bookings, depend entirely on macroeconomic conditions (employment levels, inflation rates) that impact travel demand.
Corporate travel is in fact one of the indicators of economic activity and is influenced the most by the macroeconomic conditions. During a recessionary period both corporate and leisure travel plummet. Amidst rising unemployment and declining disposable income levels, consumers cut back on their travel plans first before making adjustments to other expenses.
Advertising, which constitutes a significant source of revenue for online travel service providers, depends on the level of business activity as well. During recessionary times, businesses cut back on media and advertising spending and this translates into lower online advertising revenue for travel portals such as expedia.com, priceline.com etc.
Foreign exchange rates impact international travel demand
Leisure travelers unlike corporations do not hedge themselves against foreign exchange fluctuations. Hence, the spot foreign exchange rates determine the consumer demand for international travel. In times of adverse foreign exchange rate movements (such as a depreciating dollar), international travel becomes dearer and the same hotel booking and air tickets cost more dollars thereby discouraging travel bookings.
Travel service providers such as Expedia and Priceline earn revenues from international bookings in foreign currencies, incur most operating expenses in dollars and report the earnings in dollars. An adverse foreign exchange scenario could erode profits. Since an increasing proportion of bookings are coming from the less penetrated emerging economies, the exposure to foreign exchange is only expected to increase in the future.
Fuel prices impact ticket prices and reduce consumer disposable income
Rising fuel prices has the immediate impact of increasing airfares, which discourages travel. This not only impacts air ticket bookings but reduced travel also negatively impacts hotel bookings and destination services such as car rentals and cruises. The decline in the overall bookings hits travel service providers' revenues.
With a rise in fuel prices, airlines are no longer able to offer significant discounts on bulk bookings to travel agents such as Expedia. With the result, the revenue margins earned by travel service providers (under the merchant model) take a hit. The lower revenue margins translate into lower profit margins for travel service providers.
Rising internet penetration benefits OTAs & portals like Kayak
While over 56% of travel bookings in the US happening online, less than 32% of Europeans book travel over the internet. The penetration of internet in Asia is still much lower. Hence, with rising affluence in the emerging economies of South Asia and increasing adoption of internet and e-commerce, the proportion of travel bookings over the internet are expected to rise in the future, a trend which favors the online travel providers such as Expedia, Priceline, Travelocity and Orbitz among others.
Airline industry consolidation of capacity impacts ticket prices
The airline industry has been suffering from chronic overcapacity leading to lower occupancy rates. This coupled with high volatility in fuel prices has led to the following structural changes in the aviation industry.
Domestic airlines have recently reduced capacity and increased fares. In addition, the threat of carrier bankruptcies and the emerging prospect of industry consolidation, as evidenced by the recent mergers of United Air Lines with Continental Airlines and Delta Air Lines with Northwest Airlines, could lead to additional decreases in capacity and reduce the amount of tickets available to online travel service providers for bulk purchase under the merchant business model. Going forward, the air seats capacity is expected to increase at a lower rate compared to the demand for air travel. This shall not only increase the airfares as a whole but also as consumers shy away from travel, the hotel bookings and other travel services are also expected to be hit by this, leading to lower revenues growth for travel service providers.
Airlines are increasingly selling tickets online directly from their own websites, thereby eliminating the middle man(online travel agents). With the result, online travel service providers have been compelled to remove processing fees on air ticket bookings and cancellation / rescheduling fees in excess of those charged by the airline itself.
Hotels and lodging industry tied to travel demand
During the recessionary period of 2008-09, as travel declined as a whole, so did the hotels occupancy rates (the proportion of hotel rooms occupied per year). To meet the operating expenses (since hospitality business has a significantly higher proportion of fixed costs), the hotel owners resorted to offering discounts and lower tariffs. This led to a drop in the Average Daily Rate (the average rate per night of hotel booking). Hotel bookings took a hit and adversely impacted the revenues for travel service providers.
Hotel bookings offer markedly higher revenue margins (revenue earned by the travel service provider as a percentage of the size of booking) at close to 2% compared to air ticket bookings (~3%) and cruises and car rentals (less than 10%). Hence, travel services providers make the most profit from hotel bookings.
The hotels market in Europe and Asia is much more fragmented with smaller, independent lodgings compared to in the US, where the hotel market is dominated by large hotel chains. Hotel chains are more likely to offer online bookings through their own websites, while online travel agencies such as Expedia are more appealing to small, independent hotels outside the US. Travel agencies and stand to make higher revenue margins from independent budget hotels under the merchant business model. Hence, expansion into the hotels markets in Asia and Eastern Europe presents a growth opportunity to US based online travel services providers.
Online travel services is highly competitive niche segment within travel industry
Competition in US online travel remains intense and traditional online travel companies are creating new promotions and consumer value features in an effort to gain competitive advantage.
In June 2007, Priceline eliminated processing fees for its price-disclosed airline ticket service, and in April 2008, it reduced processing fees for its domestic price-disclosed merchant hotel room service. Starting in March 2009, Expedia and Travelocity also eliminated air booking fees, and in April 2009, Orbitz followed. In April 2009, each of Expedia and Orbitz reduced booking fees on hotel room reservations. With the result, no one player could maintain a price advantage over the others on price-disclosed merchant air tickets and hotel room reservations. As a result the online travel industry as a whole lost revenues.
In October 2009, Travelocity announced the waiver of its cancellation and change fees for hotel and vacation packages, as well as an expanded hotel guarantee under which consumers who book a hotel room and then find a lower published rate for the same room anytime before the day of check-in are eligible to receive a refund for the difference.
Since consumers are now increasingly hunting for bargains and discounts, Traffic obtained through online advertising has increased as a percentage of total demand since the same consumer visits several websites before making a purchase. This increased shopping behavior has reduced advertising efficiency and effectiveness as traffic obtained through online advertising becomes less likely to result in a purchase on the web site. Therefore, online advertising expenses have increased at a faster rate than gross profit, a trend which is expected to continue.
Threat from online search engines
Large, established internet search engines with substantial resources and expertise in developing online commerce and facilitating internet traffic are creating and intend to further create inroads into online travel, both in the U.S. and internationally.
Google recently acquired ITA Software, a major flight information software company, which enables users to find flight information on the internet without using the services of Expedia, Priceline and other OTAs. Google has also invested in HomeAway, a vacation home rental service.
In addition, Google has launched a travel “meta-search” site to show searchers specific hotels and rates in addition to text advertisements. Microsoft has launched Bing Travel, a “meta-search” site, which searches for airfare and hotel reservations online and predicts the best time to purchase them. “Meta-search” sites leverage their search technology to aggregate travel search results for the searcher’s specific itineraries across suppliers, travel agents and other websites and in many instances, compete directly with online travel service providers for customers.
Trefis Forecast Rationale for Kayak's EBITDA Margin
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It refers to Earnings Before Interest Taxes Deprecation and Amortization (EBITDA), expressed as a percentage of total revenues.
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) are profits after factoring in typical expenses, such as Cost of Goods and Services Sold, Selling General and Administrative (SG&A) Expenses, and Research and Development (R&D) Expenses.
We adjust EBITDA figures to exclude non-recurring charges and non-cash charges such as Stock-Based Compensation Expenses.
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${forecast} increased from 17% in 2008 to 19% in 2010. This was primarily a result of rising revenues leading to the dilution of expenses incurred in salaries and employee benefits and other general administrative costs, over higher query volumes which resulted in the improvement of margins. However, the margins came down to 16% in 2011.
Going forward, we expect the margins to continue rising over our forecast horizon, reaching 25% by the end of our forecast period.
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Trefis considered the following factors for its forecast
- Kayak’s internet-based business, which doesn’t warrant a proportional increase in operating expenses for expansion in business
- Kayak’s revenues depend on referrals and advertising placements on its websites, both of which essentially depend on the number of visitors to its websites. Kayak is still in its initial growth phase with high, double-digit growth in revenues. Going forward we expect operating expenses to assume a smaller percentage of revenue. As stated in Kayak’s S-1 filings with the SEC:
- We designed our business model and technology platform to be highly scalable and cost efficient. Our software and systems have been designed from inception to handle significant growth in users and queries, without requiring significant re-engineering or major capital expenditures. In addition, we use a combination of our own proprietary software and a variety of public domain technologies so that as we continue to grow our user base, we do not incur significant additional software costs. Since all travel products are purchased by our users directly on the travel supplier’s or OTA’s website, we do not incur meaningful costs or overhead associated with fulfillment or customer service for those travel products. We have relatively low fixed operating costs, and the largest component of our variable operating cost is discretionary marketing.
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How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
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