Kayak’s $31 Valuation: Upside/Downside Scenario

Kayak (NASDAQ:KYAK), a leading travel search company, started trading on NASDAQ on July 20 this year with a listing price of $26 per stock. The stock registered around 28% increase in its trading value and closed at around $33 on the listing day. Having filed its initial registration document more than 20 months back, the company had stalled its IPO on account of many factors – increasingly volatile market conditions, Google’s (NASDAQ:GOOG) acquisition of ITA Software in April 2011 and the Facebook (NASDAQ:FB) IPO debacle. However, so far Kayak seems to be faring well with the stock trading in the $30-$35 range.

We have a price estimate of $31.05 for Kayak, which is at a discount of around 10% to the current market price. A rise in worldwide internet penetration, growing opportunities in international markets and a higher online advertising spend are some of the factors that favor the company. However, the intense competition from the likes of Expedia (NASDAQ:EXPE) and Priceline (NASDAQ:PCLN) amongst other, low entry barrier in the industry and potential threat from Google post the ITA Software acquisition force us to maintain a conservative estimate on the company’s future outlook.

Here, we list down certain key factors and how an upside/downside in their forecast would impact our valuation for Kayak.

1. Air Ticket Queries On Kayak: In 2011, Kayak received 754 million air ticket queries on its website, a 40% increase from 2010.

2. Online Ad Revenue Per 1,000 Queries: At $165 (per thousand) in 2011, Kayak’s online ad revenue was relatively flat year-on-year.

3. Hotel Referral Fees Per 1,000 Hotel Queries: We estimate that Kayak’s hotel referral fee per thousand hotel queries declined from $347 in 2010 to $267 in 2011.

4. Kayak’s EBIDTA Margin: At 15.7%, the EBITDA margin registered a close to 3% decline in 2011 compared to 2010.

30% Upside Scenario | $40 Price Estimate

1. Increase In Airline Ticket Queries (+15%)

Currently, we estimate the airline ticket queries on Kayak to register a CAGR of 14%, reaching 2.8 billion queries by the end of our forecast period. Given the very competitive air tickets bookings segment, we expect a high growth rate in air ticket queries over Kayak, as an increasing number of consumers look up fares on Kayak and then get directed to the OTA or airlines website for booking transactions. Additionally, unlike hotel bookings where other factors such as brand name, services, dining experience and others’ recommendations also matter, air ticket bookings for leisure travelers are essentially driven by air fares. While planning a holiday, airfare is the first thing that a traveler usually looks out for.

In light of the slated growth in online travel, if our estimate turns out to be too optimistic, there could be a considerable upside to our price estimate. If the number of air ticket queries goes up t0 3.5 billion by 2019, there will be a 13% upside to our current price estimate.

2. Rise In Kayak’s Popularity Could Contribute To Higher Ad Revenues (10%)

Going forward, we expect the ad revenues per thousand queries to rise at an average annual rate of 7% reaching $268 by the end of our forecast period. However, with macroeconomic recovery we expect the industry-wide advertising budgets to rise in the future. An increase in the number of visitors on Kayak’s websites can increase its popularity, thus allowing it to charge higher advertising prices.

By pursuing aggressive marketing and advertising, Kayak could increase its brand awareness and raise its ad revenues to $320 (per thousand) by the end of our forecast period. In such a scenario, our price estimate will increase by close to 10%.

3. International Hotel & Lodging Industry Offer Significant Growth Opportunities (5%)

Going forward, we expect Kayak’s Hotel Referral Fee per 1,000 Hotel Queries to rise to around $580 by the end of our forecast period. We forecast a significant increase in referral revenues from the hotel division because hotels are known to earn higher revenue per traveler compared to airlines. Additionally, the fragmented and comparatively unorganized nature of hotel and lodging industry outside US offer tremendous growth opportunities for online travel in international markets.

The lower internet penetration in the European markets and the rising per capita income in emerging economies are expected to drive travel demand from these markets. If by the end of our forecast period, the hotel referral fees per thousand hotel queries increases to $700, there could be a slight upside to our current price estimate for Kayak.

42% Downside Scenario | $18 Price Estimate

1. Acquisition of ITA Software By Google Could Negatively Impact Air Queries (-20%)

ITA licenses its airfare search and pricing software to Kayak under an agreement which expires in December 2013. The faring software accounts for 42% of Kayak’s overall airfare query results and airline travel queries account for 85% of total searches performed on Kayak’s websites and mobile applications. If Google does not renew Kayak’s contract with ITA or does so at unfavorable terms, then it could have a significant impact on the comprehensiveness of Kayak’s query results.

If the number of air ticket queries drops down to 1.8 billion by the end of our forecast period, our price estimate will decline by around 20%.

2. Intense Competition Might Restrict Growth In Ad Revenues (-14%)

Due to the low barrier in the online travel industry, Kayak not only faces competition from existing players but also needs to be wary of potential new entrants in the market.  The intense competition in the industry might restrict any significant growth in ad revenues in the future. If the online ad revenues (per thousand) remain more or less around the current level for the rest of our forecast period, then it will lead to around 14% downside in our price estimate.

3. Lower Growth Rate For Hotel Referral Fees (-5%)

There is a possibility of our estimates for growth in hotel booking from the international markets being too optimistic for the long run. In case the referral fees per thousand hotel queries only rises to $450 by the end of our forecast period, then it will lead to a 5% downside to our current price estimate.

4. Downward Pressure On EBITDA Margin (-14%)

We forecast Kayak’s EBITDA margin to continue rising over our forecast horizon, reaching 24% by the end of our forecast period. We have based our estimate on the premise that Kayak’s internet based business does not warrant a proportional increase in operating expenses for expansion in business.

However, the increasing competition might force the company to continuously increase its marketing and advertising expense in the future, putting downward pressure on margins. If the EBITDA margins stay constant around the current level for the rest of our review period, then our price estimate will drop down by 14%.

See Our Complete analysis for Kayak’s stock here

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