How Kayak’s Business Model Creates Value

Kayak (NASDAQ:KYAK) is a travel search company that offers travel suppliers and online travel agencies (OTAs), such as Expedia (NASDAQ:EXPE), Priceline (NASDAQ:PCLN), Orbitz etc., an efficient channel to sell their products and services to potential customers. It provides travel buyers a one-stop research solution to find the best fares, along with travel management tools and services such as flight status updates, pricing alerts and itinerary management.

Delaying its IPO for over 20 months, Kayak finally got listed in June 2012. However, along with its last quarter earnings in December 2012, Kayak announced being acquired by Priceline in a deal that valued the company at $1.8 billion. Earlier this month, Priceline won the U.S. antitrust approval to purchase the company.

The transaction is expected to close in the first quarter of 2013, and Kayak will operate as an independent unit within Priceline. Kayak believes that Priceline’s global reach will accelerate its growth trajectory in international markets and help it further develop as a company.

In this article we provide a snapshot of how Kayak makes money and the important segments that contribute to its growth.

See Our Complete analysis for Kayak’s stock here

Who Are Kayak’s Customers? How Does The Company Make Money?

Kayak’s website and mobile applications facilitate easy research and comparison of fares and other travel related information collected from numerous travel websites, both supplier websites and online travel agencies’ websites. It simplifies a user’s search process by facilitating easy price comparison for various travel products. Once users select a flight, hotel or other travel product, Kayak directs them to the travel supplier or an online travel agency to complete the purchase. In some cases, users can complete the booking without leaving the Kayak website altogether.

Kayak’s services are free for travelers. It earns its revenue via: (i) referrals to travel suppliers and OTAs, also known as distribution revenues, and (ii) ad revenues from advertising placements on its websites and mobile applications.

While Kayak complements online travel agencies by directing the online traveler to their websites, earning distribution revenue in the process, it also competes with the OTAs for advertising placements on its websites.

What Are The Most Important Segments That Contribute To Kayak’s Growth?

Kayak has witnessed robust top line growth in the last few years. It made $225 million in revenue in 2011 and earned 16% operating profit on the same, which is constant across all its business segments. We estimate Kayak’s operating margin to increase in the future as the company earns higher revenue on a similar cost base. Since Kayak is an Internet-based business, we feel it does not warrant a proportional increase in operating expenses for expansion in business.

1. Advertising

Kayak offers advertising placements on its websites to travel suppliers and vendors, and charges them either on cost per click (CPC) or cost per impression (CPM) basis. Advertising revenue contributes approximately 58% to Kayak’s revenue.

Kayak received close to 900 million queries on its website in 2011, out of which 14% were generated from its mobile platform. Going forward, we estimate growth in Kayak’s mobile platform to be an important factor in increasing the number of queries on Kayak. Kayak believes that it has a more loyal mobile user base as compared to the PC user base. With a growing adoption of mobile devices around the world, we expect the mobile share of Kayak’s total queries to increase to 24% by the end of our forecast period.

Kayak charged $165 per 1000 queries (on average) in 2011 for advertising placements on its websites. We forecast the figure to increase at a steady pace over our review period. Macro-economic recovery and increase in advertising budgets combined with an increase in the number of visitors to its websites will increase Kayak’s popularity. Additionally, we believe that Kayak’s acquisition by Priceline will expand its global coverage, increasing its visibility in the international market. (Read Related Article: How Can Kayak’s Acquisition Fuel Priceline’s Growth?)

Currently, Kayak earns $20 per 1000 mobile queries, but we estimate the number to increase in the future as it takes additional initiatives to develop its mobile platform.

2. Airline Ticket Referral

Revenue from airline referrals account for 27% of Kayak’s total revenue. Airline ticket queries represent almost 85% of the total queries received by Kayak. While we forecast a slight decline in the percentage contribution, as online hotel bookings witness faster growth, airline queries will continue to account for a substantial majority of total searches on Kayak’s website.

Kayak currently earns approximately $80 referral fees per thousand air ticket queries. Going forward we expect the referral fee to decline at an average rate of 2% over our review period.

The airline industry is perhaps the most competitive of all travel products. It has been suffering from chronic overcapacity, leading to lower occupancy rates. This coupled with high volatility in fuel prices has led to structural changes in the aviation industry. Additionally, airlines are increasingly selling tickets online directly from their own websites, thereby eliminating the need for online travel agents. As a result, online travel service providers have been compelled to eliminate booking commissions to price the air ticket bookings at parity with the airlines themselves.

3. Hotel Referral

Kayak earns 14% of its revenue from hotel referrals and hotel queries account for 13% of the total queries received on its websites. We expect this number to marginally increase by the end of our forecast period. Unlike air ticket bookings, while looking for hotels, travelers usually conduct an extensive search for the best fares, and comparison of fares available over different online travel agencies is an important aspect.

Though airline ticket search accounts for majority of the queries, Kayak earns a much higher referral fee on hotel bookings compared to airlines. In 2011, Kayak earned approximately $270 referral fees (on average) per thousand hotel queries. We estimate the fee to almost double over our review period.

The lack of standardization in hotels, especially in international markets, necessitates comparison between the rates quoted on different sources – online travel agencies and hotel websites. To achieve higher occupancy rates, hotels are willing to incur high distribution expenses in the form of commissions to the online travel agencies and commission on referrals. With increasing competition, we expect Kayak’s hotel referral fee to increase with rising hotel tariffs.

4. Car Rentals & Cruise Referral

Car rentals and cruise referrals account for a mere 3% of the queries received by Kayak and contribute only 1% to its overall revenue. Though we forecast an increase in the absolute number of car rentals and cruise queries, we estimate the same as a proportion of total queries to remain around the current level.

Car rentals and cruises are essentially destination services. They constitute a lower percentage of the total travel budget and are booked after a traveler decides on an air ticket and/or hotel stay.  These are also often offered complementary or at discounted rates by online travel agencies to attract bookings.

Kayak earns on an average $80 referral fee per thousand car rental and cruise queries. As the rising competition leads to shrinking distribution budgets, we estimate the fee to decline at a steady pace over our review period.

Our price estimate of $30.95 for Kayak is at a discount of around 20% to the current market price.

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