Factors Driving Kayak’s $26 Valuation

Kayak (NASDAQ:KYAK) started trading on Nasdaq in July 2012 after having stalled its IPO for over 20 months. With an initial listing price of $26, the company’s stock has registered an over 30% increase in value and, based on the recent quarterly earnings, it seems to be going strong.

Kayak is a leading travel search company and, due to the discretionary nature of leisure travel, its growth is directly related to macroeconomic conditions such as employment levels, inflation rates, fuel prices, forex rates, etc. However, apart from the general macroeconomic variables, there are several other factors that can considerably impact Kayak’s future outlook. Here, we discuss some of these factors in detail.

See Our Complete analysis for Kayak’s stock here

Increasing Threat From Google Post ITA Acquisition

With the acquisition of ITA Software in April 2011, Google (NASDAQ:GOOG) has launched its own online travel search product and a hotel and flight search tool. While this, in general, poses a major threat to travel search companies, Kayak’s dependence on ITA makes it all the more vulnerable to the potential threat. Airline travel queries account for 85% of total searches performed on Kayak’s websites and mobile applications, and ITA currently contributes close to 39% to Kayak’s total airfare query results.

Kayak has been registering rapid growth in its user base and total number of queries received. Though we continue to believe that its future growth could be restricted by the Google-ITA deal, we think the negative impact might not be as adverse as originally anticipated. The US Department of Justice kept certain clauses before giving a go-ahead to the acquisition, ensuring that Google does not completely kill the competition among the providers of comparative flight search websites in the U.S. (Read Related Articles: How Big A Threat Is Google To Kayak’s Business? and Kayak’s Valuation Significantly Impacted By Google-ITA Deal)

Kayak To Benefit From Increasing Internet Penetration

Given the increasing worldwide online penetration, the Internet has become an integral part of travel planning as it enables travelers to refine searches, compare destinations and view real-time pricing.

The global Internet penetration is currently estimated at 32.7% (78.6% in North America, 61.3% in Europe, 39.5% in Latin America and 26.2% in Asia). With rising affluence and e-commerce growth, especially in emerging economies, the proportion of travel bookings over the Internet is expected to rise in the future. This trend favors online travel providers such as Expedia (NASDAQ:EXPE), Priceline (NASDAQ:PCLN), Travelocity and Orbitz among others, in turn benefiting portals such as Kayak.

Hotel Markets Outside US Provide An Added Opportunity

The hotel markets in Europe and Asia are much more fragmented with smaller, independent lodgings compared to the U.S., where the hotel market is dominated by large hotel chains. Large hotel chains are more likely to offer online bookings through their own websites while online travel agencies are more appealing to small, independent hotels outside the U.S. Additionally, travel agencies stand to make higher revenue margins from independent budget hotels under their merchant business model. Hence, expansion into hotels markets in Asia and Eastern Europe presents a growth opportunity for online travel services providers.

Travel service providers earn a higher revenue margin on hotel bookings (>20%) compared to air ticket bookings (~3%) and cruises and car rentals (less than 10%). We estimate hotel referral fees to contribute close to 24% to Kayak’s valuation and believe that leveraging growth in Europe and Asia could be a good long-term strategy for the company.

Rising Online Advertising Spend

IDC estimates the annual expenditure for global online travel advertising was over $5 billion in 2011 and forecasts that to grow at a compound annual rate of 15% through 2014. Since Kayak derives over 50% of its value from advertising, we think the trend will do well for the company’s future valuation.

With improving economic stability, the global travel market is bound to witness an increase in the years ahead and travel-related advertisers will continue to devote significant resources in advertising their travel products and services. As the online advertising market continues to witness strong growth, we expect to see an increasing amount of travel advertising spending to migrate from traditional offline advertising channels to online advertising.

On the flip side, the traffic obtained through online advertising has increased as a percentage of total demand since the same consumer visits several websites before making a purchase.  This increased shopping behavior has reduced advertising efficiency and effectiveness as the traffic obtained becomes less likely to result in a purchase on the website.  Therefore, online advertising expenses have increased at a faster rate than gross profits, a trend we expect to continue in the future.

Our price estimate of $25.95 for Kayak is at a discount of over 20% to the current market price.

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