Despite Europe skid, online agencies stay the course

By
|

In the heady days of late 2004 through the middle of last year, Cendant and Sabre laid plans for international growth, then tossed around billions of dollars, picking off high-profile European travel companies. For Cendant, the prizes were wholesaler Gullivers Travel Associates and its OctopusTravel consumer business, then eBookers. Sabre subsidiary Travelocity landed Lastminute.com.

The spin-off doctors at IAC/InterActiveCorp, meanwhile, busied themselves with a separation agreement, cast off their travel businesses and created Expedia Inc., which seemed content to grow in Europe at a measured pace without a grand shopping spree.

Priceline.com also got busy, making relatively small purchases of two European hotel distributors, Active Hotels and Bookings B.V., for around $300 million.

U.S. online travel agencies had visions of storming the Continent and gaining share. The reality has been more humbling, as earnings for the four major U.S. online agencies plummeted in the fourth quarter.

In the quarter ended Dec. 31, Expedias net income dropped 43% to $25.2 million. Cendant Travel Distribution Services earnings before interest, taxes, depreciation and amortization (EBITDA) was a $332 million loss. Pricelines profits declined 24.2% to $3.8 million. Travelocitys operating loss more than doubled to $24.5 million.

There was no single culprit to blame for these results but rather a number of snags, ranging from slowed growth in Europe to an impairment charge for an overvalued acquisition and myriad other company-specific issues.

While it can be argued that these companies are still in the early days of their international conquests, the snags offer at least some cause for concern. Expedia and Cendant, in particular, have cited stiff competition abroad from supplier-direct Web sites, European tour operators going online and other problems. Suppliers clearly took share from intermediaries in 2005 in Europe. That was particularly true in the U.K., Europes most mature market.

The international arena is key for the online agencies. In the U.S., margins on domestic hotel sales have come under pressure, supplier Web sites have made gains and price-conscious consumers are turning to metasearch engines for bargain-hunting. 

Still, their fourth-quarter stutter-step begs the question: Are the expansion plans of online agencies a bust? Or was this less-than-stellar performance a momentary pause in a quest to plant their footprints on the global travel market?

Organic growth vs. acquisition

Expedias international business in 2005 produced 22% of its gross bookings, up from 12% in 2003, but the rate of organic growth in Europe slowed in the second six months of 2005 compared with the first half of the year.

Dara Khosrowshahi, CEO of Expedia Inc., told analysts that the fourth quarter wasnt as strong as we hoped it would be. But he also said the company had embarked on a multiyear evolution from efficient transaction engine to world-class retailer of travel products and services.

Expedia has plenty of fuel to power its growth, which it hopes to nurture organically, for now at least, rather than through acquisition. Expedia.com and its international siblings are in the fold, as is Hotels.com, which did $1.9 billion in gross bookings in 2005. That makes Hotels.com, with a presence in 29 countries, the fifth-largest online agency in the world, according to Expedia.

Expedias challenges last year were most acute in the U.K., the companys largest Europe market, where there was increased competition from supplier Web sites and traditional tour operators who upped their efforts to bring their businesses online, Khosrowshahi said. But Expedias businesses are growing in France, Italy and Germany, which became profitable for the first time last year. Expedia will launch in Japan by the end of 2006, he said.

Dont think short-term, Khosrowshahi advised, as Expedia is investing in its international businesses, technology and people, and will break out from the pack in 2007.

Sabre, meanwhile, is largely hitching its wagon to the development and growth of its Travelocity business, which has been the key driver of Sabre revenue expansion.

Travelocity is caught up in integrating Lastminute.com, which it acquired in July for almost $1.2 billion, and turning it into its lead brand in Europe. Travelocity spent about $9 million in the fourth quarter to accelerate the integration efforts.

Expanding the brand and growing the business are expensive. In the fourth quarter, Travelocitys operating income according to generally accepted accounting principles (GAAP) consisted of a $9.3 million gain outside of Europe and a $33.7 million loss in Europe.

Sabre officials view 2005 as an investment year for Travelocity. They forecast that 2006 will be a growth period, with Travelocity projected to post GAAP operating income of around $50 million and global revenue growth of about 40% to an estimated $1.2 billion. 

However, there will be some bumps in the first quarter of 2006, Sabre said. Travelocity is projected to lose $8 to $10 million more than in the first quarter of 2005 because of the seasonality of Lastminute.coms business and the consolidation of Zuji, the Asia-Pacific travel seller that Travelocity acquired in January.

Travelocitys strategy, which hinges on growing internationally and increasing its net rate programs, includes providing more U.S. inventory to Lastminute customers, and offering more European inventory to Travelocity users.

In North America, Travelocity, with its Customer Championship program and other initiatives, is growing faster than the competition. Revenue in North America in the fourth quarter grew 28%, marking the eighth consecutive quarter that revenue increases surpassed 25%.

One new element in Travelocitys North America strategy has it putting new emphasis on Lastminute.coms existing U.S. Web site at http://us.lastminute.com, marketing it as a lifestyle site.

We believe it is a good brand for people looking for last-minute opportunities, not only to travel but just to get out to dinner, a concert or a show, said Joel Frey, a Travelocity spokesman. Of course, Travelocity will continue to be the primary brand [in North America], and Lastminute.com will be marketed in more online and viral ways, so the costs will be relatively low.

Cendant spends, then pays

Cendants difficulties in Europe have been well publicized. TDS EBITDA fell from a $101 million profit in the fourth quarter of 2004 to a $332 million loss in the fourth quarter of 2005. 

Cendant said 2005 earnings were hurt by the $425 million impairment charge it took related to its online consumer travel businesses, and $28 million in integration costs tied to its purchases of Orbitz, eBookers and Gullivers Travel Associates (GTA).

Cendant acquired Orbitz in November 2004, eBookers in February 2005 and GTA in April 2005. With too much of eBookers inventory available only for off-line booking and with its 14 European Web sites underperforming in other respects (the technology platform is unstable and cant scale to handle growth), eBookers loss was $30 million in 2005.

We did three years worth of acquisitions in six months, Ken Esterow, president and CEO of the TDS Travel Industry Services Americas Group, said at a recent conference. That was painful.

Cendant, which recently hired Gordon Bethune as TDS chairman and plans to recruit a CEO and spin off the unit in October, tied much of its woes to underperformance in Europe, particularly at eBookers. Officials project that eBookers will remain in the red in 2006 but will show improvement in 2007.

Cendants acquisition objective was to attain scope and geographic reach as an order maker by selling directly to consumers instead of just crunching transactions through Galileo and other businesses as an order taker.

GTA, for example, is a wholesaler of hotel, ground and sightseeing products with 32 offices in 24 countries, primarily in Europe and Asia. Cendant plans to make Gullivers content available to Galileo-wired travel agencies around the world and to Cendants consumer businesses, including Orbitz, CheapTickets, OctopusTravel.com, HotelClub.com and RatesToGo.

Like its peers, Priceline.com warned that growth has slowed in the online domestic travel market because of supplier-direct initiatives and because increased airline load factors and higher hotel occupancy rates limited inventory to intermediaries.

With Pricelines name-your-own price opaque business declining, it has emphasized its new retail business in the U.S. and Europe. Priceline Europe, with hotel reservations services covering about 40 countries, grew its gross bookings in the fourth quarter about 88% on an organic basis, to $158 million.

Pricelines European hotel business is humming because of its purchase of U.K.-based Active Hotels in September 2004 and Netherlands-headquartered Booking B.V. in July 2005.

With the European hotel market more fragmented than in North America, the two hotel distribution businesses have contracts with about 20,000 chains and independent hotels in 40 countries. Bookings can be taken in 12 languages.

Pricelines European business has traditionally focused on the U.K., but its strategy now is to expand rapidly into other European countries with its retail hotel business.

In Europe, we believe Priceline took meaningful market share from our major competitors in the fourth quarter, said President and CEO Jeffery Boyd, adding that the company would double its marketing spending in Europe to almost $20 million in the first quarter.

Scott Devitt, a senior analyst of Internet consumer services at Stifel Nicolaus, said Priceline Europe was uniquely situated, comparing it to the position Hotel Reservations Network, which became a force in U.S. hotel distribution as Hotels.com, held four years ago.

The nature of Pricelines business in Europe consists of consumers booking hotel rooms outside of packages and, in many cases, purchased in combination with a supplier-direct air ticket from a discount airline, Devitt wrote to investors. In other words, Pricelines European business operates in the most fragmented, least competitive component of the market.

Devitt told TravelWeekly.com that suppliers are gravitating toward Priceline Europe in part because it is taking about a 15% margin on hotel sales, whereas competitors are demanding at least 20%.

Devitt said the online agencies are in investment mode in Europe and have the ability to grow in the region -- although they are finding it tougher than initially envisioned.

The ability to distribute inventory in Europe exists for those with the best assets over a long period of time, Devitt said. Expedia has grown organically in Europe. Cendant is struggling in terms of acquisitions, and Sabre is still in execution mode, so you dont really know what you have there yet.

Devitt noted that Travelocity, which was late in its entry into the merchant hotel arena, has performed flawlessly in the U.S. over the last few years.

However, Devitt said Expedia is the best-positioned online agency in Europe, although he previously thought that by now Expedia would be in a period of leverage instead of facing a period of investment.

Analysts unimpressed

Over the long term, Devitt is not bullish about the prospects of the online agencies, saying that the industry doesnt have the most compelling compensation in terms of margin structure.

They own no content or inventory, and suppliers are pushing back, Devitt added.

Heath Terry, a Credit Suisse analyst, took an even harder line, arguing that 2006 is likely to be difficult for the online travel agent model.

While Expedia owns the most valuable set of travel assets online, we believe that pressure from suppliers, competitors and the emergence of the travel-search model will intensify in the year ahead, impacting growth rates, booking margins and operating margins, Terry said in a February client note cited by the Associated Press.

Caroline Bremner, global travel and tourism manager for Euromonitor International in London, said suppliers grew a bit faster than intermediaries in western Europe in 2005, but intermediaries are projected to answer back by 2007, reversing the trend. That dynamic is particularly evident in the U.K., Europes largest travel market, she said.

Suppliers share of online transactions in the U.K. are projected to increase 3.5 points to 42.7% in 2006, while the intermediaries share is forecast to drop 3.5 points to 57.3% in 2006.

I dont believe the online players have run out of steam. They are increasingly looking at ways to refresh their product offer, along with continued investment in their Web technology, Bremner said.

And, she added, 2006 may represent a year of consolidation in terms of systems and market strategy, especially by groups such as Cendant and Sabre. By 2010, Euromonitor International projects a stable balance of power between the channels with intermediaries maintaining over 55% of the online market.

Bremner said the online agencies business models are expected to adapt in the same way weve seen the suppliers evolve in response to a changed marketplace.

Hugo Burge, president of U.S. operations and international business for U.K.-based Cheapflights, said he expected the U.S.-headquartered online agencies to play a considerable role in the European market.

But Burge also said that Europe has a history of proving more challenging than U.S. companies predict.

It is important to recognize the very different marketplace in the different European countries, Burge said. The T word -- tour operator -- is an important part of the equation that seems to have been understated over the last few years. It is also worth noting that the low-cost airline market is much more advanced and brutal [in Europe] than in the U.S., which is a challenge because low-cost carriers dont play ball with the online travel agencies.

Tour operators and established brands like Thomson Holidays, TUI and Thomas Cook have challenged the online agencies, but the online agencies are resilient, Burge said.

In the global context, the online travel agency model is still youthful, with plenty of growth to come in geographical reach, consolidation and product evolution, Burge said. The European market alone is widely expected to outgrow the U.S. market within three years.

Henry Harteveldt, Forrester Researchs vice president of travel research, said the next few years should be viewed as investment periods for the online agencies, with Asia-Pacific becoming a primary focus.

Europe is a matter of rounding out, filling in the blanks, whether it is through acquisitions or start-ups, Harteveldt said. I see Russia, central Europe and the Middle East as areas of investment.

But Harteveldt also cautioned that the U.S. online model doesnt exactly translate abroad, and that Europe and Asia are not slam dunks.

In Asia, people use mobile phones to make payment and they also go to convenience stores, Harteveldt said. PayPal is the third-most preferred method for travelers to pay for things online in the U.K., and phone support and instant messaging will be critical.

Michael Cannizzaro, director of information services for PhoCusWright, agreed with other analysts that tour operators and suppliers provide tough competition for online travel agencies in Europe.

However, the online agencies surpass their rivals in their potential to provide personalization, community, planning and research tools, he said.

Although few observers predicted the scope of Cendants problems in integrating eBookers, which itself grew through acquisitions, Cannizzaro said that the online agencies activities in Europe seem to be proceeding according to plan.

It seems like the big agencies are relatively on track, Cannizzaro said. They may have missed a few points in terms of Wall Street, but they are still on the growth trajectory that we would expect.

To contact reporter Dennis Schaal, send e-mail to [email protected].

Comments
JDS Travel News JDS Viewpoints JDS Africa/MI