Priceline (NASDAQ:PCLN) is a leading online travel agency (OTA) that primarily offers hotel and accommodation reservations, as well as other travel services such as car rentals, airline tickets, vacation packages, destination services, cruises and travel insurance. Priceline brings together travelers and travel suppliers on a single platform via its online travel portals—priceline.com, booking.com, agoda.com, rentalscars.com, breezenet.com and lowestfares.com. The company also entered the meta-search space recently through the acquisition of Kayak, a leading travel search site.
In this article we provide a snapshot of how Priceline makes money, its key markets and the important segments that contribute to its business.
Who Are Priceline’s Customers? How Does The Company Make Money?
Priceline’s customer base includes travelers seeking hotels, air tickets, car rentals and cruises, and travel suppliers who advertise on its website. The company sells travel products and services to travelers via:
1) The price disclosed model, under which the company earns revenue on a per transaction basis.
2) The opaque pricing model, under which the company earns the difference between the price bid by the traveler and the price charged by the travel supplier. The company also earns revenue by selling advertisements on its website.
What are the key markets for Priceline?
Priceline offers its products and services in North America, South America, Europe and Asia-Pacific regions. Its booking.com, priceline.com and rentalcars.com brands offer services in all of these regions while the agoda.com brand caters primarily to the Asia-Pacific market.
The company is increasing its presence in emerging markets such as Asia-Pacific and South America. Driven by growing Internet penetration rate, the growing use of mobile devices, e-commerce adoption and rising disposable income, the demand for online travel services in these regions has risen substantially in recent years, and is expected to continue rising in the future. Priceline has capitalized well on this opportunity. Its booking.com brand now has 275,000 hotels in over 180 countries compared with 185,000 hotels in 160 countries last year. Also, the company is taking steps to close in on Expedia’s lead in the U.S. The acquisition of Kayak, which has more than 50% share of the meta-search space in the country, will help Priceline draw more traffic to its website. Additionally, the company also launched its first and biggest offline ad campaign for booking.com in the country.
Important segments that contribute to Priceline’s Growth
Since 2008, Priceline’s revenue has grown by more than 20% annually. Sailing with the current boom in the online travel market, the company generated revenues of $5.3 billion and posted operating profit margin of 37% (constant across the business segments) in 2012.
Going forward, we forecast Priceline’s revenue to grow, propelled by robust growth in the online travel market in the European, Asia-Pacific and South American regions, where the company targets to rapidly expand its footprint. However, we expect the growth to be suppressed due to high degree of competition from other OTAs and search engines that are waiving off various fees charged to the customers, such as processing, cancellation and change fees. For the same reason, we also expect operating margins to remain range bound over our review period.
1. Revenue Margin on Hotel Bookings To Decline
The hotels business is the primary source of revenue and holds strategic importance for Priceline, which is evident from the steady growth in the revenue share of the division, from 93% in 2008 to 98% in 2012. The division also has the highest revenue margin (~20%) among all divisions of the company.
The company offers services in the U.S. under the merchant model while its international operations are conducted under the agency model. Net revenues under the agency model are generated in the form of commissions and bookings fees, resulting in lower revenue margins. Under the merchant model, there is scope for earnings higher margins as users bid for services and the booking is completed on Priceline’s website itself. While we expect Priceline’s expanding international footprint to drive growth in the division’s gross bookings and revenue, we estimate a gradual decline in its commission on hotel bookings as the share of international bookings in total bookings has been rising.
In addition, room rents in the Asia-Pacific region are comparatively lower than North America and Europe, which could lower the average revenue per room for Priceline. As the number of hotels directly selling their inventory online increases and industry competition rises further, fees and commissions for Priceline will decline.
2. Airlines’ Commission To Remain Capped Due To High Industry Competition
Even though airline tickets division contributes about 10% to total gross bookings, its revenue share is less than 2%. The airline industry operates in a highly competitive environment with very low profitability. Along with demand volatility the industry experiences much higher supply rates than demand, causing overcapacity. Thus, airline companies charge minimal airfares to fulfill capacity. Additionally, airline companies are increasingly selling tickets online directly on their own websites, thereby eliminating the need for OTAs. The above factors do not leave much scope for OTAs to charge high margins; thus, we expect revenue margin for the airlines division to gradually decline from 2% in 2012 to 1% in 2019.
Even with such low margins bigger OTAs such as Priceline continue with air ticket bookings as these form an integral part of airline travel. Bigger OTAs can also easily bundle different products and services into a wholesome offering.
As global economic conditions improve further and consumers rapidly switch from traditional to online method of ticket booking, we forecast the division’s gross bookings to more than triple, boosting revenue to about $120 million by 2019 from $67 million in 2012.
3. Revenue From Cruises & Car Rentals To Experience Small Absolute Growth
The cruises and car rental services division contributes 1% and 2% to Priceline’s revenue and gross bookings, respectively. Historically, cruises and car rental services were bundled with destination services or vacation packages. In recent years, these services have seen higher demand leading OTAs to offer these as stand-alone services. Given that these were earlier often bundled with other offerings, there is scope for charging higher prices in order to enhance revenues.
We expect both revenue and gross bookings from the division to experience double-digit growth through the forecast period. However, this will not make significant difference to the company’s top line, as we estimate the division’s revenue contribution to be around 1% over the forecast period.
4. Advertising Division Revenue To Grow But Still Contribute Less Than 1%
Historically, the advertising division has contributed less than 1% to Priceline’s revenue, as advertisers kept their budgets tightened during the global economic slowdown. The recent acquisition of Kayak, which derives the majority of revenues from advertising, presents Priceline with an opportunity to earn a higher proportion of revenues from advertising in the future. Also, as the company expands its international presence and user base, advertisers (primarily travel suppliers) could be attracted to the website, enhancing advertising revenue for the company. While we forecast advertising revenue to increase, we do not expect the division’s revenue contribution to change significantly over our review period.
Although we forecast Priceline’s revenue to grow in the long-term, we expect the growth rate to decline due to increase in competition from other OTAs, search engines and travel suppliers. Our price estimate of $642 for Priceline marks our valuation at a discount of about 25% to the current market price. We are in the process of updating our model for Kayak’s acquisition.