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Monday, May 3, 1999

An Investment Opinion
by Alex Schay

Even Pricier Priceline

The last time we visited Inc. (Nasdaq: PCLN) in this space the "name your own price" Web auctioneer had closed for bidding at a hefty $15.4 billion -- the market capitalization figure assumes the conversion of about 42 million common share equivalents. Betcha' didn't think it could almost double in a little over a month since then, did you?

The current price for the company now stands somewhere near $27.4 billion, which is pretty mind-boggling even when granting the potential growth characteristics (more than a 400% top line increase is expected in 1999). Perhaps more surprising is the fact that no financial results accompanied the near-100% rise in the intervening period between columns.

First quarter results will be released tomorrow, though, and was down $23 1/8 to $139 1/4 today. Of course, to quote Graham & Dodd, investing in "unseasoned companies in new fields of activity" always requires the reality jolt provided by incremental financial data in order to moderate opinions (or exacerbate already unreasonable expectations) about the market opportunity. Here's a brief summary of the April announcements just to get you caught up: announced a new agreement for its adaptive marketing program, jettisoning Capital One Financial (which apparently exercised its option to end the program on May 1st, subject to renegotiated terms, which clearly didn't go anywhere) in favor of First USA - the largest issuer of Visa cards. The company stated that the five-year deal could add roughly $200 million to's top line. The firm expanded its offering of hotels by 238% compared with the December 1998 number and also reported:

- 75,000 hotel room nights were filled since the October launch (5000 a week as of April)
- $125 million in home mortgage offers were accepted (10,000 requests) in the first 3 months of operation
- 330,000 airline tickets were sold in its first full year of actual operation (20,000 a week) with 18 major airlines participating, filling 35% of all "reasonable" offers
- $11 million in new car sales in test market
- 1,000,000 unique users logged onto the service in its first year (higher than eBay) with 300,000 new "uniques" coming on board every quarter

In addition to this company news, a horde of brokerages initiated coverage with buy ratings in April. I'll assume that 53.5% of you don't know much about the company, even though some online finance folk probably skewed the results of the study that released today:

"The top four most-recognized e-commerce brands among all U.S. adults are:, 101.3 million adults (51.7%);, 91.1 million adults (46.5%); eBay, 63.1 million adults (32.2%); and E*TRADE, 58.6 million adults (29.9%)."

That was a bad joke -- with the marketing spending and the average user passing on a favorable word to 18 other people, the exponential "awareness" result is not surprising. Taking a step back nevertheless, developed a reverse-auction hybrid business model, which is something in between a traditional auction and a Dutch auction, and opened for business in July of 1998 (some of the business patents are still under dispute). Priceline refers to itself as a "demand collection system." Using a highly charged "name your price" strategy, the firm collects individual consumer offers -- backed by a credit card -- for a particular product or service at the price level chosen by the consumer (the offers stay active for a specified period).

Priceline then approaches its network of participating sellers and in effect represents "x" amount of demand, or alternately the firm is given access to the private databases of its sellers and allowed to fulfill the demand under the price parameters established between the merchants and Priceline. Further, in order to help "bridge the gap" between the offers made by consumers and the prices demanded by suppliers, priceline has adopted two adaptive marketing programs. The first is called "adaptive cross selling," and isn't as deviant as it sounds.

Adaptive cross selling attempts to cement the deal with consumers by offering multiple product options. For instance, suppose a customer offers to buy an airline ticket that is below the price required by the seller. If the bid is close, Priceline might offer a second item to the consumer like a hotel room or a rental car, at a price that's blended margin (with the ticket) would be acceptable to all involved.

The second of the two adaptive marketing programs is the "adaptive promotions" venture. Under this program, sellers of various services like magazine subscriptions or credit cards offer to make up the difference between the low bid and an acceptable sale in exchange for the customers' participation in the sponsors' promotion. Say you only bid $200 for a flight, and then E*TRADE steps in and offers $50 on top of your bid in order for it to go through. In exchange you agree to open an E*TRADE account. Although Priceline only made $4 million of its $35 million in revenues in 1998 from this program, the dollars are very high margin. Priceline acknowledges in its last prospectus that a "significant" portion of its gross margin comes from these programs.

If you examine the business closely, you can see that sponsorship dollars are going to be crucial going forward. Tomorrow, we'll take a closer look at exactly what is built into the equity at this price, as well as the first quarter results.

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