OTAs: Wanna Get Away?

sagawa

The Internet has been brutal to middlemen and niche players, with platform players GOOGL, AMZN, and AAPL absorbing value with each new integrated app and market entry. Online travel has been a big exception – OTAs and GDSs have thrived, and, based on rich valuations and consensus expectations, investors expect that success to continue far into the future. We are not so sure. The travel industry – e.g. airlines and hoteliers – is consolidating, with leverage against the fees charged by OTAs and GDSs a key motivating factor. These suppliers are offering strong incentives to travelers to book directly, and will be greatly aided by new travel planning tools being integrated into the big platforms. Meanwhile, competition from alternative lodging unicorn AirBnB and the possibility of a global economic downturn threaten to squeeze the addressable market. Add in new rivalry from a raft of travel startups exploiting cheap public cloud hosting, and the digital travel market is far less cozy than at first glance. We are concerned for both OTAs (PCLN, and EXPE) and GDSs (SABR, TVPT, BME:AMS), seeing far more risk than reward at current prices. TRIP – with its ad-driven model and Instant Bookings opportunity – is preferred, pricey but likely to achieve reasonable expectations.

  • OTAs rally to rich values on aggressive expectations – The OTA sector bounced hard off a relative bottom in early Feb, buoyed by PCLN’s 4Q15 upside surprise. With the combination of EXPE and OWW, investors are expecting a tempering of rivalry to help drive profitability across the sector, as international expansion and the ongoing shift to online travel bookings drive continued long-term growth. PCLN and EXPE are expected to maintain mid-to-upper teens growth over 3 years with little deceleration, while significantly increasing operating margins. We believe that this is overly aggressive, with hotel consolidation, AirBnB’s growth, TRIPs market entry with Instant Bookings, platform integrated travel tools (Destinations on Google, etc.), new market entrants, and economic/political pressures, all hanging over the sector.
  • GDSs defending their middleman role – GDSs aggregate airline fare quotes onto a single platform for use by various OTAs and traditional travel agents, taking fees for tickets booked through their systems, passing some commission to the OTA/Agent. The 3 main GDS players – SABR, TVPT and BME:AMA – were created from reservations systems that had been spun out of major airlines. As such, each is built on decades old database and data center architecture, which limits their ability to easily adapt to the increasingly complex fare and ancillary services menus of airlines. As their share of ticket bookings is already high and facing considerable pressures, GDS operators are looking to reservation system hosting to drive growth, putting them into rivalry with lower cost general IaaS platforms, like AWS. Against this, consensus is projecting accelerating sales growth and expanding margins.
  • Consolidating travel industry pushes back – After waves of mergers, mega-airlines are flexing their negotiating muscles vs. GDS commission rates and offering strong incentives – e.g. bonus miles, free bags, upgrades, discounted promo codes, etc. – to passengers willing to book directly. LUV refuses to list its flights on GDS/OTA, while Lufthansa Group just added an $18 fee on flights not booked through its own website. Meanwhile, after the best US hotel year ever in 2015, hotel groups are also consolidating (MAR/HOT, Accor/FRHI, etc.) and looking negotiate better terms from OTAs. HLT just launched a 10% discount for its HHonors members for booking directly. “Most Favored” clauses, which protect OTAs from being undercut by many of its lodging suppliers, are being challenged by European law, and pressured by negotiations.
  • AirBnB – In 2015, AirBnB handled just over $7B in bookings, compared with PCLN and EXPE, which handled over $50B. However, McKinsey has estimated that AirBnB’s booking for 2020 could be more than $80B or 9% of the total hospitality industry. This has obvious implications for hoteliers, who will feel pressure on both top and bottom lines, perhaps driving further consolidation and adding to pressure on OTA negotiations. It will also squeeze the pool of hospitality bookings available to OTAs.
  • Platform integrated travel tools – GOOGL just launched “Destinations on Google”, allowing sophisticated travel planning and direct booking right from Search. AAPL has the potential do something similar with its Passport app on iOS. Both companies can integrate payments, e-ticketing, itinerary calendaring, loyalty programs, and other travel related services directly with the planning and purchasing of travel products. These products will not ask fees from travel services providers, and should have considerable cooperation from an industry burdened by OTA commissions. OTAs will be free to participate, but will lose many of their advantages – consumer reach, multi-product/multi-provider itineraries, etc. We note that this is also a logical direction for AMZN (which shut down its own commission-based OTA last year) and FB.
  • New competition – With cheap IaaS capacity on AWS, Azure or GCE, travel startups are proliferating, often targeting the weaknesses of traditional OTAs and GDSs – tools for building and managing complex itineraries, budget planning, poorly designed user interfaces, inflexible data base structures, etc. 55 different travel booking startups raised over $650M in 2015, not counting AirBnB’s $1.5B raise. These companies will challenge the established OTAs and GDSs to invest to improve their game, particularly in providing better flexibility to travelers in planning, purchasing and managing their trips.
  • Economic uncertainty – Historically, travel spending, both business and leisure, has been extremely sensitive to overall economic conditions – North American spending dropped 10% during the 2008 recession and 8% in 2001. This puts OTAs, with their aggressive growth and margin expectations, at particular risk, with the added pressure of heightened terrorism concerns in Europe.
  • Risks outweigh potential rewards – The bull case requires OTAs to continue to grow their share of travel bookings and maintain commission rates against a presumed stable addressable market. We believe that all of these assumptions are at risk, and with P/Es at 19-36 times these aggressive forward earnings models, we do not see room for error. In addition to the major OTAs – PCLN, and EXPE– the trends we see, particularly travel industry consolidation, new platform tools, and economic uncertainty, threaten GSDs, like SABR and TVPT, as well. TripAdvisor, with its advertising revenue model, Instant Bookings opportunity, modest consensus growth targets, and synergies with potential buyers, would seem to have the most upside.
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