Drivers To Travelzoo’s $24 Valuation

by Trefis Team
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Touching a high of $31 at the start of the year, Travelzoo (NASDAQ:TZOO) has been treading a downward path since then. While adverse macro conditions contribute to much of this decline, we believe that certain intrinsic factors, which have slowed down Travelzoo’s growth this year, are also responsible for the negative sentiment among investors.

Travelzoo reported its Q3 2012 earnings recently and the disappointing results led to a further decline in its stock price. Significant decrease in revenue from Travelzoo’s search and local deals business led to an 8% y-o-y decline in overall revenue and the aggressive investment into team expansion and product portfolio enhancement put a downward pressure on Travelzoo’s operating margins.

While there are certain factors such as the challenging economic scenario, airline consolidation, increasing expenses etc., which could dampen Travelzoo’s short term growth, we maintain a positive outlook for its long-term growth prospects. With growing strength in its hotel business driven by Getaway hotel offering, a robust increase in mobile traffic and social media integration, we believe that Travelzoo is in a good position to leverage future growth in the online travel industry.

Our price estimate of $23.80 for Travelzoo is at a premium of over 30% to the current market price. Here, we briefly discuss key factors that reiterate our belief in the same.

See our full analysis of Travelzoo

Current Investments To Drive Future Growth

Aiming to accelerate its audience growth, Travelzoo has been aggressively investing in expanding its sales force, enhancing its product offerings and improvising the content and deals offered on its websites and newsletters. The company saw a significant decline in EBITDA margin in 2011 due to increasing advertising spend on building brand awareness and higher expenses incurred on account of headcount growth to scale international expansion.

In Q3 2012, Travelzoo increased spending on subscriber marketing by $1.2 million in Q3 2012 compared to the previous quarter. Investments in headcount and subscriber marketing remain key focus areas for Travelzoo and the company expects to see a further increase in its operating expenses this quarter as a result of an increase in headcount, higher legal and professional fees and increasing costs for development of the hotels business.

While the high expense base combined with lower topline growth could slow down Travelzoo’s growth this year, we believe that the same would accelerate growth once the investments start paying off. The company intends to pull back certain expenses in line with any potential decline in revenues in the coming quarters, but remains determined to continue innovating to stay ahead of competitors.

Growing Strength In The Hotel Business

While the reduced revenue from airline bookings and packages have slowed down growth, the company has witnessed robust growth in its hotel business, primarily driven by Getaway hotel offering. Getaways, which was launched in 2011, is a voucher model which is gaining popularity among medium and small size hotels as it provides then with an opportunity to stimulate incremental sales.

Currently, Travelzoo does not offer direct online bookings for a specific date. However, it is in the process of opening up a hotel booking platform and is working towards providing its users the ability to book hotels directly via its website through mobile products. Additionally, the company intends to ramp up its hotel sales force to capture the growing demand for Getaways.

We feel that the above developments will further accelerate demand for hotel bookings, which will continue to significantly contribute to Travelzoo’s revenue growth.

Increase in Searches Via Fly.com

Travelzoo’s search division includes revenues from both Fly.com, a travel search engine, and Supersearch, a pay-per-click travel search tool. While the company has registered an increase in searches via Fly.com, the number of searches on Supersearch has declined over the years as Travelzoo diverts its marketing spend away from Supersearch and towards Fly.com.

Google’s integration of hotel search products on to their main search results page this year and Travelzoo’s focus to bring Supersearch Europe to profitability led to a decline in traffic driven to Fly.com. The company claims that it needs a strategic review of its Supersearch product to stabilize the decline in number of searches.

While Supersearch continues to be very popular with OTAs because it delivers extremely efficient bookings, the product is relatively time consuming for users compared to newer comparison models and is not so well suited for mobile.”

While we forecast a continuous decline in searches via Supersearch, we estimate the searches on Fly.com to register y-o-y growth for the rest of our review period. We feel that the launch of hotel search will power search volumes growth and the positive synergy with its core travel business will augur well for traffic at Fly.com.

Increase In Average Deals Per Market

Armed with strong management and a stable sales force division, Travelzoo deals reached 125 markets, with an approximate average deal size of 25,000 in the second quarter. In addition, the company saw greater success in distributing Local deals on other websites such as The Los Angeles Times, Lonely Planet and The New York Times via the Travelzoo network.

However, the deal revenue in Q3 2012 declined significantly on account of lower average number of vouchers sold per deal. The company feels that a highly competitive environment and its focus to only feature high-quality merchants and not to expand into categories too far from its core were the contributing factors for the decline.

Local Deals, launched in 2010, provides subscribers with high quality deals for restaurant, spa, activity, show or concert events. While we agree that with increasing competition in the deals space, the average revenue per deal is treading lower, we believe the partnership with Sysco iCare, the success of Getaways and revenue synergies with other Travelzoo businesses will help drive volumes in this segment.

Travelzoo intends to publish more deals in existing markets and target new markets to steer demand. Additionally, Travelzoo’s existing hotel relationships and growing subscriber base for its other products, like the Top 20 Newsletter, could give the company an edge over its competitors.

We have updated our price estimate for Travelzo0 to $23.81 post the Q3 2012 earnings release.

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