Travelzoo (NASDAQ:TZOO), a leading Internet media company, witnessed only a marginal rise in 2012 revenue as certain factors – challenging economic situation, airline consolidation, lower spending by online booking engines and increasing operating expenses – dampened its short-term growth. In addition to weak macro conditions, lower revenue from Local Deals and Supersearch led to a slowdown in its North American and European business. However, after a flat Q2 2012 and a disappointing Q3, the 5% annual increase in Travelzoo’s Q4 2012 earnings were a pleasant surprise.
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Despite the temporary setback, we believe that both Local Deals and searches (Fly.com) divisions will be important growth drivers for Travelzoo. The company has a strong financial position with a positive cash flow, increasing cash and no debt which support our belief in its long-term growth potential. Additionally, in our view, the growing strength in its hotel business, driven by Getaway hotel offering, robust growth in mobile traffic and social media integration, places it in a good position to leverage future growth in the online travel industry.
Travelzoo is slated to release its Q1 2013 results on Thursday, April 18, and we expect earnings to continue the growth momentum build up in Q4 2012.
See our full analysis of Travelzoo
Local Deals Business Offers Long-Term Growth Opportunities
Having suffered a setback in Q3 2012, Travelzoo’s Local Deals business witnessed steady growth during Q4 2012. Seasonal factors and continued expansion in its sales force led to a 4% and 20% sequential increase in Local Deals revenue from North America and Europe, respectively. However, a growing number of published deals last quarter was offset by a decline in average vouchers sold per deal.
With increasing Internet penetration, the rise of social commerce and the 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 think 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. So far, only a small proportion of local businesses advertise online. BIA/Kelsey, a media advisory firm, estimates that the local businesses’ online marketing spend will increase to $35 billion by 2014, compared to approximately $20 billion in 2010. 
We feel an increasing investment in building a strong sales force and its focus on high quality deals could help drive future growth in Travelzoo’s Local Deals Business. Additionally, its 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. Travelzoo has been focusing on extending its reach to additional U.S., Canadian and European cities while aiming to increase deal frequency and revenue per market. (Read: Is Travelzoo’s Local Deals Business A Good Opportunity Long-Term?)
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. Fly.com is the main focus of the company with regards to its search business and an important part of its growth strategy.
While Travelzoo is looking towards a strategic review of its Supersearch product to stabilize the decline in the number of searches, it is also investing heavily in further developing the Fly.com platform which it claims to be superior in technology compared to Supersearch.com. Additionally, Fly.com is better positioned to leverage growth in the mobile user base, which in turn can lead to higher search queries for Travelzoo. Travelzoo receives around 28% of its traffic via mobile devices and we expect the proportion to increase in the future.
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.
Increasing Operating Expenses To Accelerate Growth
Travelzoo saw a significant decline in its EBITDA margin in 2011 due to increasing advertising spend on building brand awareness and higher general and administrative expenses incurred on account of headcount growth to scale international expansion. Though the EBITDA margin increased overall for 2012, Travelzoo’s bottom-line suffered in Q4 2012 due to increasing investments in headcount and subscriber acquisition as well as higher marketing expenses.
The company anticipated high operating expenses in Q1 2013 as well due to continued ramp up of headcount, increased marketing, legal and professional fees and development costs for building its hotel booking platform.
While the increase in investments might be detrimental for short-term growth, we expect it to play a crucial role to spur long-term top-line growth. Going forward, we expect the expenses to reduce, and as Travelzoo plans to focus on growth and improved productivity, we estimate margins to stabilize in the long run.
We will update our price estimate of $23 for Travelzo0 after the Q1 2013 earnings release.Notes: