Travelzoo's value proposition is fairly compelling for its clients. In the travel business, unsold inventory is a major challenge. Unfilled airline seats, cruise cabins, theater seats, and hotel rooms are undesirable, as the cost structure in these businesses are largely fixed (e.g. it's not much cheaper to fly a route when the plane is only half booked than when it is fully booked). Even getting reduced revenue for this unsold inventory helps a lot. Travelzoo's specialty is providing a fast, flexible, and cost-effective solution for selling this inventory. Fast because there is a short amount of time between when the unsold inventory is known and when it can be sold. Flexible because the deals have to be quickly modified based on the level of demand. And cost-effective because these seats are being sold at very low margin, margin which advertising eats farther into.
When you think about the lead times, creative costs, and inflexible nature of TV, radio, and print advertising, it becomes clear how valuable Travelzoo's services can be to its customers.
The company has had a lot of success putting this proposition into action, more than doubling revenues from 2007 to today. This growth has been accomplished through organic growth, new services like Local Deals and Getaways, and geographic expansion, particularly into western Europe. Operating margins have been volatile, fluctuating between 15% and 30% over the past 5 years, as the company has tried to balance profitability with growth. Free cash flow has been similarly volatile, although solidly positive. Travelzoo's balance sheet is solid with $54 million in cash and no debt.
The Magic FormulaŽ screens have recently dug up a lot of stocks that have suffered dramatic price declines this year, such as Tempur-Pedic (TPX) and Quality Systems (QSII). Travelzoo is one of the most dramatic of all. This time a year ago, the stock traded in the mid-80's! Today it is under $22. So are we looking at the potential for another big bounce, or was Travelzoo simply a bubble stock that has come back to Earth?
MagicDiligence believes more of the latter. Revenue growth has slowed rather drastically, just 5% in the most recent quarter after several years of 20%+ growth. Management noted that they plan to increase advertising to re-ignite top line growth, but this will cut into margins in the short term. Subscriber growth has been "okay", about 6% in the most recent quarter.
I think a lot of Travelzoo's excellent 2010-11 numbers are due to building out in Europe and launching Local Deals. It will be more difficult going forward. Geographical expansion potential is limited. Travelzoo sold their Asia Pacific business in 2009, and any investor knows how weak Europe is and is expected to remain for the foreseeable future.
But perhaps the biggest issue I have with Travelzoo is that the firm has absolutely zero economic moat. Local Deals had a nice launch, but has limited potential due to direct competitors like Groupon, LivingSocial, and Google (GOOG) Offers. The search engine businesses pale in comparison to Kayak, or Priceline. Many of these also offer short-term ad placement, as do the full-service online travel providers like Expedia (EXPE). Travelzoo's services are also easily duplicated by high-traffic web portals like Yahoo! (YHOO), Microsoft's (MSFT) MSN network, or AOL (AOL). Simply stated, there is a ton of competition, much of it from established and highly trafficked sites, and very low barriers to entry in this business.
Against this backdrop, I have trouble seeing Travelzoo sustaining high long-term growth rates. However, the company does have a good brand, sizable subscriber base, and good client relationships already established. Given these factors, and modeling about 7-10% growth for the next several years, I come up with a valuation of about $26 on Travelzoo. While that is a 19% premium to current prices, that's not much of a margin of safety given the risks in the business and volatility in the stock. Travelzoo's stock doesn't get interesting until about the $15 level. At present, the risk/reward ratio is not attractive enough to garner a recommendation.
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Steve does not own TZOO.
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