We really do read our email here at the Fool. After a recent look at Priceline.com (NASDAQ:PCLN) raised a few hackles, I needed to check my ego before checking my in-box. Happily, it was nothing like the caustic vitriol that's flung our way if we dare speak ill of Sirius Satellite Radio (NASDAQ:SIRI).
In the previous article, I gave Priceline credit for pulling together some solid growth over the past year. The line that put the price on my head was this one: "I suggest that prospective shareholders should keep an eye on the revenues, which were down 13.9% to $863.7 million."
The gist of the protests was this: "Hey, idiot, revenues weren't really down because recent changes in Priceline's mix of airline tickets have skewed the numbers."
Let's clear one thing up: Revenues were down. The recent 10-K states, "During the year ended December 31, 2003, we experienced a decrease in total revenue of approximately $140 million primarily due to a decline in the sale of merchant airline tickets.." (Gross travel bookings were also down for the whole year, though they picked up in the second half.)
While it's important for prospective investors to understand how Priceline's revamped airline ticketing service kludges up the top line, what's more important is trying to predict how the new ticketing strategy will affect the bottom line in the year ahead.
Beyond opacity
Priceline became famous for its "opaque" or "merchant" ticket sales -- the kind where consumers name their own price and find out only after the purchase what time the flight runs, and whether and where there are layovers. For the past couple of years, those opaque sales have waned.
Streamlined online competition from the likes of Orbitz (NASDAQ:ORBZ), InterActiveCorp's (NASDAQ:IACI) Expedia, and Sabre's (NYSE:TSG) Travelocity, along with Web-enabled bargains offered by the airlines themselves, make it easy and inexpensive for consumers to get exactly what they want. As a result, fewer travelers are interested in saving a few bucks at the risk of buying the proverbial pig in a poke -- like the mystifying flight my wife recently took between Chicago and New Orleans via Atlanta.
In response, last quarter Priceline launched its "retail" ticket system. These ticket sales are essentially the same as you would find at competing travel sites, or the airlines themselves, where the carrier, fares, and route are fully disclosed before purchase.
Priceline investors should take notice, for three reasons: (1) Retail tickets will begin to cannibalize some of Priceline's opaque ticket sales, (2) retail ticket sales carry a much lower margin than do the opaque tickets, and (3) the two types of tickets leave a very different impression on the income statement.
Book 'em, Dano
With opaque tickets, the full cost of the ticket, taxes, and Priceline's fee is counted as revenue. Further down the income statement, the cost of the ticket and taxes is accounted for as cost of revenue. However, when the firm books a retail ticket, it records revenue in the amount of the fee only. There is no cost of revenue for the retail ticket because Priceline served only as an agent. There was never a ticket in "inventory," as with the opaque model.
To see what I mean, consider the following imaginary tickets to beautiful Gary, Ind., sold according to both models. It shows that, while the revenue figure varies greatly according to the ticketing model, the gross profit doesn't take the same wild swing. (The fees are fictional.)
| Model | Fare | Tax | Fee | Gross Booking | Revenue | Cost of Rev. | Gross Profit |
|---|---|---|---|---|---|---|---|
| Opaque | $400 | $50 | $10 | $460 | $460 | $450 | $10 |
| Retail | $400 | $50 | $5 | $455 | $5 | $0 | $5 |
As Priceline anticipates selling a greater number of retail tickets, the revenue figure will fall, providing a misleading picture of the firm's actual travel sales. To account for this, management has suggested using gross bookings as a more reliable means of comparing between past and future sales.
But here's where it gets even trickier. Priceline makes a lot more money on the opaque tickets than on the retail variety. It takes 1.5 to 2.5 retail tickets to bring in the same gross profit as a single opaque ticket. This means that investors need to keep sharp watch on gross profits to see how the company is performing in comparison to past periods.
Volume and the loss leader
You might be wondering why Priceline is willing to take such a big reduction of its cut on plane tickets, which are still the company's most important products. The answer is volume. Like Wal-Mart (NYSE:WMT), which earns mere pennies per sale, Priceline is hoping that it's retail airline sales will become popular enough to make up for both the thinner margins and the lagging sales of the more profitable opaque tickets.
So far, the strategy seems to be working, but unfortunately, it's not possible to confirm the results with any accuracy. The company refuses to provide specific numbers that would bear out CEO Jeffrey Boyd's vague assertion in the last conference call that "the new product is selling more tickets as a whole and the gross profit contribution from increased retail ticket sales more than offsets the opaque loss."
(Yellow card for Mr. Boyd and Priceline. Hey, it's nothing personal. I subject all corporate management to the old Cold War credo, "Trust, but verify.")
The other part of the retail-ticket strategy is to use it sort of like a loss leader, similar to those mountains of ridiculously cheap soda that block the doors at my neighborhood Target (NYSE:TGT) from time to time. Priceline hopes that by bringing in customers for the new retail airline tickets, it will be able to sell them additional goodies, such a car rental and hotel booking. Opaque car rentals and hotel rooms carry higher margins than the retail air tickets, and both of those segments of the business are already booming. Total rental days for cars increased 26% last year, and hotel-room nights were up 39%.
The crystal ball
Fellow Fool Rich Smith recently discussed signs that Americans, no longer so spooked and cash-strapped, are getting ready to travel again. Priceline seems well-positioned to profit from any increased demand, but whether that means rewards for investors is a bigger mystery. The company looks forward to gross-bookings increases of 25% to 30% for the first half of 2004, and earnings around $0.34 per share. Profitability sets it apart from some of its larger peers, but its thinner margins going forward will make it difficult to stand out from the increasingly tight competition.
No. 3 online travel outfit Orbitz, which was founded by a consortium of airlines and thus benefits from some sweetheart deals, grew its gross bookings almost three times more quickly than Priceline did last year, and expects 2004 revenues to tick up nearly 40%.
Sabre Holding's No. 2 site, Travelocity, didn't grow so quickly, but it predicts 27% top-line growth for 2004. No. 1 InterActiveCorp's travel businesses posted 32% growth in gross bookings, and a 40% jump in revenues. In addition to being big and growing quickly, both of these two sport reasonable ratios of enterprise value to free cash flow.
That's why travel-smitten investors would do well to think twice about Priceline. The new strategies may have put it back in the race, but Fools know better than to bet against the ponies at the front of the pack, especially when they're increasing their lead.
Have your own Take on Priceline's prospects? Sound off on our Priceline.com discussion board. And if you'll be heading for the friendly skies anytime soon, check out the Fool's Travel Center and the Cheap Air Fares discuss board.
Motley Fool Contributor Seth Jayson loves the Shatner ads, but he would rather bike than fly. He owns no stake in any firm mentioned above. The Motley Fool is investors writing for investors.
