FOOL PLATE SPECIAL
An Investment Opinion
Priceline Adds Three New Carriers to the Mix Brian Graney (TMF Panic)
November 17, 1999
Investors in e-commerce intermediary priceline.com (Nasdaq: PCLN) woke up to some big news today as the company announced that UAL Corp.'s (NYSE: UAL) United Airlines, AMR Corp.'s (NYSE: AMR) American Airlines, and US Airways (NYSE: U) have signed up for its "name your price" leisure airline ticket program. With the new airlines on board, priceline users now have the ability to buy specially priced tickets from all of the major U.S. carriers, which combined represent 90% of the U.S. airline market and fly more than 500,000 empty seats on average each day. Investors cheered the news, sending priceline's share price up more than 10% this morning.
At priceline, bagging the final stragglers to round out its airline ticket fleet is being regarded as a major coup. "We view this addition of three major domestic airlines as an extremely strong endorsement of the value of priceline.com's system to our airline partners," said chairman and CEO Richard Braddock. "The Internet will continue to be the travel industry's most competitive sector, but priceline.com has clearly carved out a unique franchise for itself and is now in a position to serve the entire airline industry.''
The company has been quick to tout the benefits that airlines can derive from its demand collection services, namely incremental revenues on seats that would have otherwise gone unsold through the traditional distribution channels of airline ticketing agencies, travel agencies, and air travel consolidators. To keep some level of control over their revenue-management systems, airlines in return have the flexibility to pick and choose which routes to include in the program, how many tickets to offer, and what discount to accept from priceline users.
However, not everyone in the airline industry has supported the priceline concept. Former AMR CEO Robert Crandall publicly questioned the concept in a speech earlier this year, saying the whole idea of special or off-tariff discounts "doesn't make any business sense." Of course, judging from the incredibly dismal value creation history of airlines in general over the years (cited most recently by Warren Buffett in this article), pretty much the same "bad business" argument could be thrown right back at the entire airline industry.
Selling tickets off-tariff doesn't seem like bad medicine to the airlines when the deal includes copious amounts of stock purchase warrants in a high-flying Internet company. Delta Air Lines (NYSE: DAL) took the most risk by signing up with priceline earlier than any of the other big carriers. As a consequence, Delta is reaping the biggest windfall from priceline's Mach speed price appreciation. That should make the Atlanta-based carrier's shareholders smile, though the situation must have its rivals angrier than those wacky first class passengers currently fuming at United about ditching its crystal salt and pepper shakers for ordinary sachets.
Late last week, Delta exercised the warrants from its 1998 agreement with priceline to acquire more than 16.5 million shares -- effectively at zero cost. Instead of paying the exercise price of $0.93 per share, Delta simply sacrificed some 2.1 million additional shares that were issuable under the original warrants for 18.6 million shares. Based on priceline's closing price on Friday, Delta's windfall on paper roughly equaled a startling $934 million, which is equivalent to 86% of its total net income for fiscal 1999.
After some financial juggling between the two companies, though, Delta's priceline purse works out this way:
-- $125 million for 2.08 million shares sold back to priceline founder Jay Walker
-- 6 million shares of convertible preferred stock, which were received in exchange for an equal number of priceline common shares
-- 8.5 million common shares with a current market value of about $650 million
-- new warrants to buy 5.5 million priceline shares at a price of $56 5/8 per share
At the end of the day, that's still not too shabby for slightly more than a year's worth of partnering work with priceline. UAL, AMR, and US Airways shouldn't expect the same kind of return from their priceline warrants, but missing out on at least part of the action proved to be too hard to pass up in the end. UAL and AMR will each receive warrants for 5.5 million priceline shares, while US Airways is set to receive warrants for 1.5 million shares.
Of course, this warrants issuance business will catch up to priceline and be dilutive to shareholders at some point down the road. But right now, the company and its airline partners appear to be having too much fun tallying up the potential short-term rewards to worry about such things.