Peaking at $31 in January this year, Travelzoo‘s (NASDAQ:TZOO) stock has been on a downward journey since then. Though the company managed to post marginal growth in the first two quarters, its earnings fell significantly in Q3 2012. While the 8% y-o-y decline in revenue can be attributed to lower revenue from Local Deals and SuperSearch, Travelzoo’s rising operating expenses contributed to 42% y-o-y decline in net income.
Owing to macro headwinds, Travelzoo witnessed a slowdown in both its North America and Europe businesses with the former posting a sharper decline on account of airline consolidation, reduced spend from online booking engines and a decline in average number of vouchers sold per deal. Though we agree that the near-term challenges will slow down growth, we remain optimistic on Travelzoo’s long-term growth prospects. (Read: Drivers To Travelzoo’s $24 Valuation)
Here we point out certain key trends that could impact Travelzoo’s future outlook.
Increasing Investment In Headcount & Subscriber Marketing
Increasing advertising spend for building brand awareness and higher general and administrative expenses led to a sharp decline in Travelzoo’s profit margins last year, from 27.2% in 2010 to 15.6% in 2011. The company kept a target to hire 50 additional sales staff this year and the continued investment to increase headcount put a downward pressure on Travelzoo’s bottom-line in Q3 as well.
High investment in headcount and subscriber marketing combined with the lower revenue base was the primary reason for the steep decline. The majority of the increase in operating expenses was in North America as operating expenses in Europe were relatively flat. Despite tough macro conditions, Travelzoo witnessed continued profitability in Europe.
Travelzoo estimates the expenses to increase next quarter as well as it aims to expand its sales force, invest in its audience base and accelerate product development.
While the increase in investments might be detrimental for Travelzoo’s short-term growth, we expect it to play a crucial role to spur long-term top-line growth. Going forward, we estimate the expenses to reduce, and as Travelzoo plans to focus on growth and improved productivity, we estimate margins to stabilize in the long run.
Decline in Search Revenue
Travelzoo’s search revenue registered a $1.9 million y-o-y decline in Q3 with majority of the decline coming from North America due to lower revenue from hotels. The company faced difficulty in acquiring traffic in the region due to Google’s integration of hotel search products on to its main search results page. While Google’s “hotel finder” enables users to compare and book hotels that are found across the web, the “Google flight search” tool provides flight options and prices for various carriers, simplifying user searches for travel information.
While we estimate the searches on SuperSearch to continue declining, we forecast the searches on Fly.com to register y-o-y growth for the rest of our review period. While Google remains a big threat, we think the launch of hotel search and the positive synergy with Travelzoo’s core travel business will power search volumes growth at Fly.com.
Lower Voucher Sales Per Deal
Local Deals, launched in 2010, provides subscribers with high quality deals for restaurants, spas, shows or concert events. Travelzoo claims to differentiate itself from group-buying sites like Groupon, Living Social and AOL’s Wow.com by leveraging its existing hotel relationships and growing subscriber base for its other products like the Top 20 Newsletter.
The lower than expected revenue from Local deals was one of the primary reason for Travelzoo’s dismal performance in Q3 2012. Revenue declined by $1.2 million on account of intense competition and the company’s decision to not expand too far from its core offering. Additionally, macro factors led to low consumer interest, which combined with seasonal factors and weak conversion process led to a decline in voucher sales per deal.
The intense competition has already forced some small players to exit the market while the existing companies continue to struggle and rationalize their businesses. However, Travelzoo is confident that its investment in sales force expansion and product development will be the driving force for its long-term growth. The company remains committed to ramping up investment in audience growth, across email, mobile and social user bases. We feel that tapping alternate platforms could help it increase its deals business in the future.
Rapid Growth In The Getaway Platform
While travel revenue declined due to lower advertising spend by some online booking engines, airlines and vacation packagers, the same was offset by continued growth in Getaway hotels offering. Travelzoo registered a significant increase in hotel revenue with 45% y-o-y growth in the Getaway format.
Travelzoo extended its local deals voucher program from restaurants and museum tours to upscale resorts in North America and Europe. The Getaways deals usually include a night or two at a relatively high-end hotel or resort within a two-hour drive or short flight from subscribers’ homes and include a fine-dining experience or resort credit plus other extras.
Travelzoo considers its hotel business to be a strategic long-term investment and much of its product development investment is focused on developing its hotel booking platform.
Our price estimate for Travelzo0 to $23.81 is at a premium of over 30% to the current market price.