Trends Behind Travelzoo’s $23 Valuation

Travelzoo (NASDAQ:TZOO) is a leading global Internet media company that allows travel, entertainment and local businesses to market and sell their services to its vast 26 million users subscriber base. The company has several publications and newsletters across the globe. Travelzoo also operates SuperSearch.com and Fly.com search engines that allow users to find best travel sites and prices on flights. Additionally, the company operates local deals and getaway services that provide its subscribers with high quality deals for restaurants, spas, shows, concerts etc.

Travelzoo’s stock price has increased by more than 30% since the start of the year driven by higher spending by vacation packagers and growth in the getaway hotel deals. Our price estimate of $23.32 for Travelzoo marks our valuation at a discount of about 20% to the current market price as we believe growing competition will put pressure on certain drivers including ad revenue per subscriber, average revenue per deal and searches via Supersearch.

In this article, we provide a quick snapshot of how Travelzoo makes money, the important segments that contribute to its business and the key factors driving its valuation.

See our full analysis of Travelzoo

What Are The Key Markets For Travelzoo?

Travelzoo offers its services in North America, Europe and Asia-Pacific. The company divested its stake in the Asia-Pacific business in 2009, which is now being operated by Travelzoo (Asia) Ltd. and Travelzoo Japan K.K. under a license agreement with Travelzoo. The company does not have material economic interests or significant ongoing involvement with the Asia-Pacific business. While the company generates over 70% of its revenues from North American operations, the revenue share of Europe is increasing as growth in the North American business is slowing down.

Travelzoo derives the majority of its revenue from advertising, primarily listing fees paid by travel, entertainment and local businesses to advertise their offers. The company also earns revenue from merchant agreements with local deals and getaway advertisers. In addition, airlines and travel agencies pay Travelzoo for displaying them in the search results on Fly.com and Supersearch.com.

What Are The Important Segments That Contribute To Its Growth?

Although, Travelzoo’s revenue has historically seen consistent double-digit growth, its revenue grew by only 2% in 2012 due to a sharp decline in advertising revenue. The company made $151 million in 2012, and earned almost a 20% operating profit margin on the same which is constant across its business segments. With a revenue contribution of 57%, advertising is the company’s primary source of revenue. Local deals are next with 32% revenue contribution, followed by search with 11%.

1). Growth In Subscriber Base To Be Limited By A Decline In Ad Revenue Per Subscriber

Despite consistent annual declines in advertising revenue per subscriber driven by higher competition, Travelzoo’s revenue from advertising has increased in recent years due to the growth in its subscriber base. However in 2012, its advertising revenue declined by 14%, as 9% growth in its subscriber base was offset by a more than 20% decline in advertising revenue per subscriber.

With a large number of publishing forums such as Travelzoo website, Travelzoo Top 20 e-mail newsletter, Newsflash and Travelzoo Network, the company benefits from a broad subscriber base. While the company sells advertising space in both North America and Europe, the latter has greater scope for subscriber growth and ad rate increases as the business in the region is less developed than North America.

The IAB Europe’s annual AdEx Benchmark survey shows that the online advertising market in Europe witnessed continued strong growth, with a growth rate of about 15% in 2011 and 12% in 2012. In Europe, Travelzoo operates in France, Germany, Spain, and the U.K, which are among the top 10 online markets in the region by ad spend, and together account for over 70% of the total online ad spend. Although Travelzoo’s presence in the most attractive markets in the region positions it well to leverage the online advertising growth in Europe, such prospects for the region will also attract competition and put pressure on advertising rates charged by the company.

We forecast single-digit growth in advertising revenue through the review period since an increase in subscriber base is offset by competition fueled annual declines of 3% in advertising revenue per subscriber.

2). Long Term Decline In Revenue From Local Deals

The local deals business for Travelzoo which was launched in the third quarter of 2010 has been a significant revenue generating opportunity for the firm. The company is differentiating itself from group-buying sites such as Groupon by leveraging its existing relationships with hotels and customer base from publishing forums and by targeting more affluent customers who have an appetite for higher-end deals.

It also launched Getaway in 2011, under which promotional deals are offered to consumers based on a voucher selling model. Since Getaway is gaining popularity among medium and small size hotels, the company is taking steps to increase its sales force. Additionally, Travelzoo is in the process of opening up a hotel-booking platform and is working towards providing its users the ability to book hotels directly via its website through mobile products.

While we forecast revenue from local deals to increase in the short term, we expect it to decline in the long-term as average revenue earned on a deal declines by more than half, owing to an increase in competition from other local deals sellers such as Groupon and LivingSocial.

3). SuperSearch To Offset Rise In Searches Via Fly.com

Travelzoo’s search division includes revenues from both Fly.com, a travel search engine and Supersearch, a pay-per-click travel search tool. While the company has registered an increase in searches via Fly.com, the number of searches on Supersearch has declined over the years due to increasing competition from other search engines and marketing spend being diverted from Supersearch towards Fly.com.

Historically, Fly.com was only an airfare search engine enabling users to find and compare flight options and real-time fares. In November 2011, hotel and car rental search functionalities were integrated into fly.com. Unlike air ticket bookings, hotel reservations require the travelers to conduct extensive search for best fares. Fly.com simplifies a user’s search process by simplifying the comparison of fares available over different online travel agencies.

While we forecast Fly.com to register y-o-y growth of over 10% for the rest of our review period driven by growth in hotel searches and positive synergy with the company’s core travel business, we expect a steady decline in searches via Supersearch to limit growth in total number of searches.

4). Profit Margin To Remain Range Bound Owing To Competition

To serve its growing subscriber base better, Travelzoo has been investing heavily in advertising campaigns, expanding its sales force and enhancing its product offerings. Travelzoo’s EBITDA margin decreased significantly from 24% in 2010 to 13% in 2011, due to aggressive investment into team expansion and product portfolio enhancement. As the company slowed investments in 2012, EBITDA margin increased to 19%.

We expect the investments to start paying off this year leading to EBITDA margin of 25% on a 13% increase in revenue. Thereafter, we forecast it to remain range bound on account of increase in competition and high subscriber acquisition costs.

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