Travelzoo (NASDAQ:TZOO) ventured into the social commerce space with the launch of Local Deals in August 2010, by allowing subscribers to purchase vouchers for deals from local businesses such as spas, hotels, restaurants, etc. at attractive prices. Though it continues to derive the majority of its revenue (>60%) from advertising – revenue from merchant agreements for Local Deals and Getaway advertisers (~26%) is an important earnings stream for the company.
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Expanding its product offerings with the addition of the Local Deals and Getaway platforms (in 2011) was an important factor for Travelzoo’s rapid growth in the last few years. Local Deals revenue increased by more than 8x between 2010-11, but the growth rate slowed considerably in 2012. While Local Deals revenue registered a significant y-o-y increase both in North America and Europe in Q2 2012, the segment posted a significant decline in Q3 2012. However, the business rebounded in Q4 2012, with an increase in Local Deals revenue from both the regions.
With increasing Internet penetration, rise of social commerce and expanding online travel market, the deals business has immense long term growth potential. However, while the advantages of entering this market are apparent, the low entry barrier pitches Travelzoo against a large number of existing competitors as well as potential new entrants in the market.
Nevertheless, we believe that Travelzoo’s entry in the Local Deals space is a good long term strategy and believe that the company has the capability to retain its competitiveness in the deals business. We estimate Local Deals to contribute near 20% to Travelzoo’s valuation.
See our full analysis of Travelzoo
What Are The Growth Opportunities In The Deals Business?
By leveraging the rise in social and online media, e-commerce simplifies the buying and selling of products and services by connecting millions of users with service providers across the globe. Though the concept of social buying has existed for a long time, it gained popularity with the rapid adoption of social platforms such as Facebook and Twitter.
A social buying website purchases bulk deals from a subscriber that enables them to bargain a higher discount rate as compared to that offered by traditional discount coupons. A user would prefer using social buying websites such as Travelzoo and Groupon, as they offer a large number of published deals at highly discounted rates. The merchant also benefits from the use of social commerce websites as it enables them to market their products for free and only pay when they get a customer for their product or service.
So far, only a small proportion of local businesses advertise online. BIA/Kelsey, a media advisory firm, estimates that local businesses’ online marketing spend will increase to $35 billion by 2014, compared to approximately $20 billion in 2010. 
What Are The Potential Risks/drawbacks In The Deals Business?
The most inherent drawback of the deals business is the low-entry barrier in the industry. The business models of social buying websites is easily replicable, which is evident from the fact that there are over 500 social buying sites across the world. Travelzoo’s Local Deals business competes with big players such as Groupon, Living Social, Google Offers as well as numerous other smaller players in the market.
As a result of intense competition in the deals business, the revenue earned by social buying websites’ as a proportion of the deal voucher face value has been treading a downward path. We expect the proportion to continue declining over our review period.
What Are The Factors That Give Travelzoo A Competitive Edge?
A large user base, existing relationships with various hotels, a trained sales force and the focus on high quality deals are some of the factors that differentiates Travelzoo from other players in the market.
A highly competitive environment, seasonal factors and known challenges with its own conversion process led to a slowdown in Travelzoo’s Local Deals business last year. Though the intense competition is likely to persist, Travelzoo believes that its core strength lies in its ability to monetize its 26 million user base.
Additionally, it has the ability to leverage its existing hotel relationships as well as its diverse products portfolio, including the Top 20 Newsletter and e-mail News Alerts. Travelzoo’s huge subscriber base provides it with access to big mailing lists that sets it apart from its competitors. The company currently generates approximately 2.9% of the entire U.S. travel search traffic. 
Travelzoo has the added advantage of a highly trained sales force which has prior experience in selling local offers for many years. The company increased its headcount by 67 last year and intends to further expand its sales force this year to meet the increasing demand.
Travelzoo has a stringent quality standard for screening its deals. We feel that its focus on high quality deals could help drive future growth in its Local Deals Business. While its strategy to only feature high-quality merchants was one of the contributing factors for lower deals revenue in Q3 2012, Travelzoo believes that quality experience leads to referral behavior that in turn helps its brand thrive over the long term.
Currently, Travelzoo does not offer direct online bookings for a specific date. However, it aims to roll out its new hotel booking platform that will enable its users to book hotels directly via its website or through mobile products. With rampant growth in its sales force, the company intends to ramp up the number of hotels and deals in its portfolio in the future.
Travelzoo deals are presently available in over 116 markets and the company is focused on extending its reach to additional U.S., Canadian and European cities.
We believe that Travelzoo’s entry into the Local Deals space fits in well with its business model of publishing global travel deals online. The social commerce market offers immense growth potential for global Internet media companies such as Travelzoo. Though the low entry barrier opens up the market to new players, we feel that Travelzoo’s decision to enter the deals space was a good business decision and believe that the company is well equipped to retain its competitiveness in the market.
Our price estimate of $23 for Travelzo0 is almost in line with the current market price.Notes: