Kayak is a travel search company whose website and mobile applications facilitate easy research and comparison of fares as well as other related information collected from various supplier websites and online travel agencies. The company seems to have put its IPO plans on hold after the Facebook (NASDAQ:FB) debacle as it wants to wait for market conditions to improve before it goes ahead with the public listing.
The outlook for Kayak depends on the performance of travel industry as a whole and due to the discretionary nature of leisure travel, revenues for online travel service providers depend entirely on macroeconomic conditions such as employment levels, inflation rates, fuel prices, forex rates, etc. Apart from economic variables, there are several other factors that can considerably impact Kayak’s future outlook. Here we provide a comprehensive view on some of those factors.
Acquisition Of ITA Software By Google Could Pose A Threat
In July 2010, Google (NASDAQ:GOOG) 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 accounts for 42% of Kayak’s overall airfare query results and airline travel queries account for 85% of total searches performed on Kayak’s websites and mobile applications.
With the regulatory approval of the acquisition in April 2011, Google can create its own flight search tool which enables people to find comparable flight information on the Internet without using Kayak’s services.
Alternatively, Google may not renew ITA’s current agreements with the online travel agencies such as 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 of the comprehensiveness of query results and, consequently, on the revenues and operating margins of Kayak.
Rising Internet Penetration To Benefit Online Travel Agencies & Portals Like Kayak
Given the increasing worldwide online penetration, the Internet has become an integral part of the overall travel planning process as it enables travelers to refine searches, compare destinations and view real-time pricing.
According to PhoCusWright’s Global Online Travel Overview (April 2011), the global online leisure and unmanaged business travel segment is expected to grow twice as fast as the total global travel market, with gross booking in the online segment expected to surpass $300 billion globally in 2012.
Global Internet penetration is currently estimated at 29% (77% in North America, 58% in Europe, 35% in Latin America and 21% in Asia). With rising affluence in emerging economies of South Asia and increased adoption of Internet and e-commerce, the proportion of travel bookings over the Internet is expected to rise in the future. This trend favors online travel providers such as Expedia (NASDAQ:EXPE) , Priceline (NASDAQ:PCLN), Travelocity and Orbitz among others, in turn benefiting portals such as Kayak.
Expansion In Hotel Markets in Europe and Asia To Provide An Added Opportunity
The hotel markets in Europe and Asia are much more fragmented with smaller, independent lodgings compared to the U.S., where the hotel market is dominated by large hotel chains. Large hotel chains are more likely to offer online bookings through their own websites while online travel agencies are more appealing to small, independent hotels outside the U.S. Additionally, travel agencies stand to make higher revenue margins from independent budget hotels under their merchant business model. Hence, expansion into hotels markets in Asia and Eastern Europe presents a growth opportunity for online travel services providers.
Hotel bookings offer markedly higher revenue margin (revenue earned by the travel service provider as a percentage of the size of the booking) at close to 25% compared to air ticket bookings (~3%) and cruises and car rentals (less than 10%). Hotel referral fees contribute close to 29% to our price estimate for Kayak, and hence leveraging the growth in Europe and Asia could benefit the company’s valuation in the long term.
Increase in Online Advertising Spend
With growing economic stability, the global travel market is bound to witness an increase in the years ahead. We therefore believe that travel providers and travel related advertisers will continue to devote significant resources to advertise their travel products and services. With the projected growth in online advertising market, an increasing amount of travel advertising spending is expected to migrate from traditional offline advertising channels to online advertising opportunities.
IDC estimates that the annual expenditures for global online travel advertising was over $5 billion in 2011 and forecasts the same to grow at a compound annual rate of 15% through 2014. Since Kayak derives over 50% of its value from advertising, we feel the trend will do well for the company’s future valuation.
On the flip side, 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 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.
We estimate Kayak’s eqity value price to be worth $850 million, or approximately $25.16 based on our current estimated share count.