It seems harsh to cut 40% off a stock's value because of a one-cent shortfall in earnings, but priceline deserved it. It had created unrealistic expectations for the profitability of its important airline-ticketing business. Now that sales in tickets have begun to slow, investors realize that the stock does not have the potential they thought. It's still a good business with a recognizable brand name, but management's lack of candor has cost it some goodwill.
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It sure is. The concern on the Street is that priceline's central business, airline ticket sales, won't scale at projected rates. That's bad news for priceline, since it derives about 80% of its revenue from airline tickets. If sales slow there for an extended period, then priceline's revenue growth will suffer badly. The real problem, though, is not that sales aren't scaling fast enough, but that expectations for revenue growth were way too high.
Of course, we all know that it's a bad idea to evaluate priceline's business by its revenue. The company has taken abuse from every financial rag -- including The Motley Fool -- for booking the entire price of the airline tickets it sells as revenue. It's a somewhat disingenuous practice. Priceline takes no risk in the exchange, since it takes money from the customer before obtaining the ticket from the airline. True, the cost of the ticket is reflected in costs of good sold, so gross profit includes only priceline's take in the exchange. But priceline won't break out the costs of its goods by category, so investors don't know what their airline-ticketing margins are.
Priceline brought this week's troubles upon itself. It was only a matter of time until investors realized that priceline won't be able to scale its airline business fast enough to justify its $2 billion market cap. If we assume that operating costs will come in at the anticipated levels and that priceline will fall one cent -- or about $1.7 million -- short in earnings solely because of a $25 million ticketing shortfall, then priceline's margins for tickets is around 6.8%.
How much in future earnings can priceline expect from airline tickets? At 6.8%, priceline generated $19 million in gross profit from tickets last quarter, and will do a little over $17 million this quarter. That still represents a 102% increase from the year-ago quarter, but it continues a weakening trend. Sales in airline tickets seem to have reached a plateau at a level that is nowhere near sufficient to drive significant cash flow.
But airline tickets represent more than just sales to priceline. They are a great marketing tool. People may well not come to priceline to save a few dollars on groceries, but they'll come for the hundreds of dollars they can save in airline fares. Once they are familiar with the service, folks should feel more comfortable with other applications. And so they have: As priceline has expanded its offerings and drawn customers, airline tickets have made up a smaller and smaller percentage of total revenue, falling from 87% in the second quarter of last year to 80% this year.
Trouble is, that's still a very significant percentage. Priceline's service is expanding, the company is close to operating profitability, and it has one of the best brand names on the Internet, as Jeff Fischer reported on Tuesday. The only problem is the expectations that it has set for itself and its investors. Management hasn't made the effort to clarify its revenue and margins -- in fact, it seems to have purposefully obfuscated them. It also appears to have set its revenue targets too high. The result is that, even though it may be a solid company, the stock is in freefall and the company is subject to ridicule.
It doesn't pay to try to pull the wool over the eyes of investors.
Your Turn:
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Related Links:
Priceline as Rule Breaker, Rule Breaker, 9/26/00
Priceline.com: Name Your Own Earnings, Fool on the Hill, 7/25/00
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