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Undervaluedness of Travelzoo

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By Dan8558
November 15, 2004

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I have been following the discussions on this board regarding Merck and since many of you are interested in finding cheap stocks I thought I would share my analysis of Travelzoo, as I believe it is cheap at its current price despite being up 1640% (according to Yahoo!) in the last 52 weeks. It seems a little ridiculous to buy Merck and hope for a double in 3-5 years when we may be able to make much more than that by buying Travelzoo.

Travelzoo is essentially a marketplace where travel companies can advertise plane tickets, hotel rooms, cruises and vacation packages. Whatever... the important thing is to note that this is an Internet company. Since there is no inventory and no product to manufacture this is a very light business model with gross margins above 97%. They are profitable and free cash flow positive with earnings per share up 160% year over year for the quarter ending June 30, 2004. Earnings for the quarter ending in June were $1.3 million with free cash flow right in line at $1.34 million. Revenues increased by about 68% year over year. I should also point out that the number of shares actually decreased over the past year, and no options have been issued during 2003 or the first half of 2004. The float is 1.9 million shares, and an amazing 86% of the float is sold short.

The discipline that Travelzoo shows in the issuing of options may be due to the fact that the ownership is highly concentrated in the hands of Ralph Bartel. Mr. Bartel owns 87% of the outstanding shares. He is the firm's Chairman of the Board, CEO, CFO and Secretary. It is nice to see an executive who has the fiscal discipline and typing skills to be his own secretary. Obviously Mr. Bartel CONTROLS this company, so we need to know if he is any good. As evidence of his competence I offer the fact that he runs an Internet company whose stock is up greater than 1600% in the last year. Impressive, no?

One interesting tidbit that I found by reading the most recent 10Q is the following.

"...the shares are not listed on a recognized national exchange or on the NASDAQ National Market."

The shares are, in fact, listed on the NASDAQ, so I am not sure why this statement appears in the 10Q. If anyone could enlighten me I would be appreciative. Perhaps this statement was a valid a couple years ago, but was never removed due to an oversight (maybe Mr. Bartel needs to hire some help).

There are some other key statistics that I believe are important to understand the Travelzoo picture. The subscriber growth over the last year was 107% and they now claim 7 million subscribers. Interestingly homepage views were up by only 54% in this time. I think there are three possibilities explaining why the growth in the number of homepage views is only half the growth in the number of subscribers. The first is that perhaps the recent subscribers are not as gung ho about using the service as are the early subscribers. Alternatively, perhaps people tire of using the service (similar to the churn experienced by Netflix) and go away. The last possibility is that maybe people close their eyes when the homepage is loaded, so they can click randomly about on the homepage and then be surprised by the location of their next vacation. If any of you have used Travelzoo it would be enlightening to hear if any of you do this.

Now for some valuation ratios...

TTM PE = 362
Forward PE = 125
Price/Sales = 52
Price/Book = 153
Price/number of home page links = 23 million
Price/subscriber = 224

The PE seems relatively high, but the forward PE rounds down to 100 which is the smallest triple digit number. The TTM PE is inconveniently high, so we'll assume it is not particularly relevant. The price to sales ratio also looks somewhat high (Taser's, for example, is only 22), but remember that this is an extremely light business model, the company is experiencing high growth and the company has outstanding management, as discussed earlier. It also helps to remember that when Corvis (an optical networking company) went public in 2001(?) they had zero revenue, giving a price to sales ratio of infinity. Even if you think 52 is high, you can't argue that it isn't finite.

The ratio of the price to the number of links from the homepage is a metric that I created. I count about 68 links on the homepage and with the Travelzoo market cap at $1.57 billion the ratio works out to be $23 million per link. This number is not particularly meaningful all alone, so let's compare this to the number for Google. Google has a market cap of $46 billion and has 10 links on its homepage giving an astronomical ratio of $4.6 billion per link. This is obviously ridiculous in comparison to Travelzoo! If Travelzoo's price to link ratio were to increase to the level of Google's the price per share would increase to $19,200 from about $96 currently. If the ratios take, say, a couple of years to equalize, Travelzoo investors would probably enjoy a market beating performance.

The price/subscriber number seems quite reasonable to me also, at least if we look out far enough. If we assume that the subscriber growth continues at 100% per year for only ten years at that time the number of subscribers will have increased by a factor of 2 raised to the power of 10 = 1024. To be conservative I will round this down to 1000. 1000 times the current 7 million subscribers gives us 7 billion subscribers in 10 years. The astute reader will notice that currently there are only about 6 billion inhabitants of this planet. This should tell you something about the popularity of this website! Assuming that the market values each subscriber at a conservative $100 (about one-half of the current value), this gives us a market cap of $700 billion, resulting in a share price (assuming no dilution) of about $62,000. This would also likely be a market beating performance.

We can also support our case by looking at the earnings growth. Last year the earnings growth was 160%, so if we assume 150% earnings per share growth over the next 10 years we get earnings of $763 in 10 years. With a PE of just 100 the share price would be $76,300, a nice increase from the current $96. If, instead, the EPS growth averages only 100% for 10 years, the earnings will rise to $8 per share (Wow! What a difference that extra 50% makes!). With a PE of 100 the stock price would be $800. This low-ball estimate for the growth rate shows there is a large margin of safety with the current price below $100.

In short, I think that TZOO is undervalued at current levels and would make a fine long-term holding.

Dan


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