Priceline as Rule Breaker

Although we ended Break Down August with a new purchase in Human Genome Sciences (Nasdaq: HGSI), we continue to run different companies through the Rule Breaker criteria. If we find one that we like more than something we already own, we'll sell shares in what we own to buy the new company.

People have long argued that priceline.com (Nasdaq: PCLN) is a Rule Breaker. Before it went public in March 1999, it was top dog, first-mover in its business. It seemingly had sustainable advantages and a good brand name. Within a month of going public, its market value rose to $20 billion, where the media called it overvalued -- and arguably it was. Sixteen months after hitting its high of $165 per share, the stock has fallen to an all-time low. Now $21 per share, priceline.com is valued at around $3.5 billion.

The business has not changed during this time, except that it has expanded. So, does priceline.com stock now have the potential for 10X in 5Y? Meaning, does it have potential for 10-fold value appreciation in five years? What about 5X in 5Y? Let's look.

Top dog and first-mover in an important, emerging industry....
Priceline.com calls its service a "demand collection system." It is new. It is electronic. Customers use priceline.com to name their own price on airline tickets, hotel rooms, and car rentals (these travel services account for more than 90% of revenue), as well as groceries, new cars, home mortgages, long-distance phone service, gasoline, and other merchandise in its Perfect YardSale. Before 2000 ends, priceline.com will offer name-your-own-price cellular phone services; and by early 2001 it will offer local phone service, insurance, and credit cards (you'll name your own finance rate, benefits, and rewards).

With 7 million registered users, priceline.com sells more than 15,000 airplane tickets daily and has sold more than 5 million in its short history. There is no close competitor offering the same depth of product and product vendors as priceline.com. It has more than 20 major airline partners, and partnerships with most of the major grocery and gasoline companies.

A sustainable advantage gained through business momentum, patents, visionary leadership, or inept competitors...
The company's advantages now mainly come through business momentum and its brand name, as well as it patents. It is the largest and most recognized e-commerce service of its kind. Its brand is the biggest "moat" around its business. It has patented its demand-collection system (the name-your-price, partnership format), though the patent has been challenged in court. Even without it, however, priceline.com has a competitive advantage.

When it comes to business momentum, priceline.com is adding more and more product lines at low additional cost, and it's expanding into Asia (Japan with SoftBank) and Europe with its patented platform. The company is expected to break even in the second half of this year and be profitable by early 2001 at the latest. This would make priceline.com only the second profitable pure e-commerce company after eBay (Nasdaq: EBAY). Profitability would make it more difficult for new competitors to emerge and challenge priceline.com.

The stronger the consumer brand, the better...
Here priceline.com shines brighter than any of the nine companies we studied in Break Down August. Independent studies show that priceline.com has one of the most recognized online consumer brands in the country.

Strong management and good backing...
The management team is listed on the website, but here's my personal rub: I'm not entirely confident of management's forthrightness. The company has endured scrutiny for its customer service, although numbers show that most customers are satisfied. To investigate, I'll randomly use the site for gasoline, groceries, and car rental and report back. The company is under even deeper scrutiny for how it books revenue (it counts the entire plane ticket, rather than just its cut), and for other accounting practices, which the Fool criticized in July.

Then there is the issue of priceline.com's dealing with WebHouse Club, another Jay Walker company (Walker founded priceline.com, too). WebHouse Club handles priceline.com's grocery and gasoline businesses. A privately held priceline.com licensee owned by Jay Walker, WebHouse Club's debt agreement with priceline.com allows for 55% ownership by priceline.com, which may represent a conflict of interest since Walker is also a majority owner of priceline.com. Heck, Jay Walker has his hands in so many different stock deals related to priceline.com that it's hard to tell what's what.

Relative Strength of 90 or higher and recently called overvalued by a significant media constituent...
Priceline.com's stock has lost 87% since April of last year, placing its dismal Relative Strength below 5. If investors hadn't pushed the stock so high during its frenzied IPO, this might be different.

Last, but not least, when it comes to the media calling it overvalued, priceline.com scores big. The company was featured on 48 Hours last week in a segment that questioned the entire business' ability to serve customers. This is even more meaningful to me than the stock being called overvalued. (Fool News wrote about this story on Friday, and a summary of the 48 Hours interview was posted by a Fool, CK$erenity.)

Summary and conclusion
Priceline.com is an e-commerce leader with an inventory-free business model. It has enough critical mass to become profitable in the next six months. It has a well-recognized brand and a few million loyal users. As it grows its business from travel to many other offerings, it stands to build incremental value at declining ongoing costs. Plus, even though it hasn't launched in Europe or Asia yet, like Amazon.com (Nasdaq: AMZN) in its niches, priceline.com stands a good chance of being the leader in name-your-price commerce overseas.

Finally, priceline.com's stock price may lend itself to decent potential appreciation in the long run. Five times appreciation from today's price would put the company at about $17 billion, lower than where it started. Some analysts believe that the $21-per-share company can earn $0.80 to $1.00 per share in 2002. So, what do you think? Answer our poll: Is priceline.com a Rule Breaker?

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