OTAs: Wanna Get Away?

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March 23, 2016

OTAs: Wanna Get Away?

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.

The SSR TMT Heatmap

Flying the Increasingly Unfriendly Skies

While many other would-be big online concepts over the years have missed the mark – e.g. Groupon and WebVan – or have been overwhelmed by AMZN/GOOGL/AAPL – e.g. LoudCloud, AskJeeves, MapQuest, etc. – OTAs have thrived. PCLN and EXPE (and C-Trip in China) have fought and acquired their way to a comfortable oligopoly as high margin aggregators between travelers and the airlines, hoteliers, and rental car agencies that serve them. Indeed, the margins on repackaged travel are sufficiently high that a whole other class of middlemen, the global distribution services (GDSs) with their time-worn computing platforms managing access to the individual reservations systems at airlines and other travel services providers.

OTAs make most of their money on hotel bookings, where fees may be 20-30% of the room rate, but take small commission payments on flights from their GDS partners. Hotels are starting to fight back, with recent industry mergers justified in part on using scale to negotiate better OTA fees. Hilton has begun offering a 10% discount for its loyalty program members that book with it directly. “Most favored” clauses in some OTA contracts which require hoteliers to offer the same prices whether a reservation is booked directly or through the OTA are under heavy anti-competitive scrutiny in the EU. Meanwhile, AirBnB, with its rapidly growing inventory of privately-owned accommodations, is taking swaths of market share from the traditional hotel industry, and, thus, the OTAs as well.

GDSs make most of their money on airline bookings, charging a commission on each ticket and passing a share on to the OTAs and agents that use their systems. A greatly consolidated airline industry is focused on cutting their payments to GDSs, offering bonus miles, special promo code fares, ancillary services (free bags, improved seat selection, etc.) and other perks, to customers that book directly. Lufthansa recently added an added $18 per ticket fee for flights bought via GDS, and Southwest refuses to list its flights through the GDS/OTA channel at all.

Both OTAs and GDSs are at risk to new competitors. Destinations on Google integrates powerful travel planning tools directly into search, enabling comparisons and purchases on complex itineraries without visiting an OTA or requiring a GDS. While quotes from OTAs will be included, airlines and hoteliers have new means to reach customers directly. AMZN shutdown their initial stab at an OTA, but with PCLN earning operating margins of nearly 40%, we expect them back. AAPL, already managing tickets and itineraries in its Passbook app, seems a natural entrant. Travel research and advertising platform TRIP, with its new Instant Booking capability, is also a threat, one that could be even more threatening in other hands. Meanwhile, a raft of new entrants, enabled by cheap capacity on AWS, Azure and GCE, are rushing in to offer their own value-added spin, aware of the rich margins earned by the incumbents.

Finally, with concerns over a possible global recession wracking the markets every few weeks, OTAs and GDSs are extremely sensitive to the economy. During the recession following the 2008 financial crisis, US travel spending dropped 25% YoY. Despite this risk, PCLN, EXPE, SABR, TVPT and BME:AMA are all up more than 20% from their early February lows, with the 2 OTAs expected to grow at a mid-to-upper teens pace and the 3 GDSs at high single digits, with all 5 projected to deliver strong margin improvement over the same period. Given the structural threats to the industry, we believe that this is very optimistic. TRIP, with fewer direct threats to its ad driven business model and the Instant Bookings opportunity, may be a somewhat better bet.

In the Beginning …

In the heady days of the internet bubble, digital businesses were supposed to be taking over the whole economy. In reality, most of those grandiose business plans failed, with those companies that succeeded, notably Amazon, Google, Apple and Microsoft, absorbing the good parts of post-crash detritus into their own platform manifest destiny. However, there were a few digital markets where the opportunity was big enough and the barriers were strong enough to allow specialists to grow big and strong. One of these was online travel.

Exh 1: Timeline of the Major OTAs

Online travel agencies flourished from the start (Exhibit 1). Competition was fierce, but the OTAs harvested market share from the highly fragmented traditional agencies and consolidated their way to a comfy oligopoly. Google kept its hands off of the business, as the top OTAs become some of its biggest ad spenders. Amazon had bigger fish to fry and ignored travel for years before half-heartedly testing a hotel booking service in 35 markets in early 2015 before shutting it down just six months later.

Priceline Group (PCLN) is the obvious leader, with annual sales of over $9B, operating margins of 35%, and a market cap of more than $60B (Exhibit 2). Born in 1997, Priceline IPOed two years later, during the height of the internet boom, having just launched experiments in applying its “Name Your Own Price” philosophy to a wide range of non-travel products and services, including groceries, gasoline, mortgages and cars. Those ambitions died with the bubble a year later, and Priceline hit profitability in 2001. Shortly thereafter, the company began to roll up competitors in earnest, buying TravelWeb and Active Hotels in 2004, Booking.com in 2005, the Asian hotel site Agoda.com in 2007, Travel Jigsaw (Rentalcars.com) in 2010, Kayak in 2013, OpenTable in 2014, and Price Match and Rocket Miles last year.

Exh 2: Priceline Group Annual Revenue, 2000-2015

Exh 3: Priceline Units Sold by Category, 2013-15

90% of Priceline’s revenues come from hotel bookings, most of which are sold on the high margin agency basis, keeping revenue passed through to the hotelier off of the books (Exhibit 3). Just 2% of its sales derive from airline tickets, most of that coming on shared commissions provided by GDS partners. Another 2% comes from car rentals and cruise line bookings, with most of the remainder driven by advertising. Just 10% of Priceline’s sales are domestic, with Europe the overwhelming source of international revenues, making the company extremely vulnerable to FX movements (Exhibit 4).

Exh 4: OTA Sources of Revenue, US versus International 2015

Expedia (EXPE) was born as a Microsoft business unit in 1996, and spun out as an independent company during the internet gold rush of ’99. In the wake of the crash, Ticketmaster (now IAC) scooped up the battered business, combining it with other travel related investments (TripAdvisor, Egencia, Classic Vacations, eLong, Hotels.com and Hotwire.com) and spinning it out again in 2005. Expedia did its own spinout of TripAdvisor in 2011 before buying travel metasearch site Trivago in 2012 and Australian travel leader Wotif in 2014. Finally, in 2015, Expedia made its biggest moves to consolidate the industry, buying Travelocity, Orbitz, and HomeAway (Exhibit 5).

Expedia’s mix is heavier on airline tickets (8%) and car rentals, cruises and other services (13%) than is Priceline’s, with just 70% deriving from the more profitable hotel bookings. Moreover, Expedia is skewed to the merchant model, by which it purchases room inventory from hotels and resells it at a mark-up. While per room commission fees are typically higher on this basis, Expedia takes the risk of vacancy and reports the full room price rather than just its fee as revenues and includes the cost of the room inventory as COGS. This results in much lower reported margins, and overstates the company’s position in hotel sales vs. Priceline and its agency model. Expedia’s US-heavy (55%) revenue mix is another major difference vs. Priceline.

Exh 5: Expedia Annual Revenue, 2002-2015

Exh 6: Expedia Sources of Revenue, 2005 vs. 2015

TripAdvisor (TRIP) has an entirely different business model, attracting users to its crowd-sourced reviews of hotels and travel activities, then monetizing via advertising. Trip Advisor has become the most visited travel web site in the world, with more than 350 monthly unique visitors, more than 320M reviews, and more than 5.3M properties listed. Trip Advisor acts as a meta-search engine, returning listings from OTAs and GDSs, alongside direct listings from hoteliers. These entities bid in real-time auction for top slots on traveler search results, paying on a cost-per-click basis. In 2014, Instant Booking was added, allowing travelers to book rooms directly from the site, with the suppliers bidding for slots and paid only when the transaction is completed. This service makes TripAdvisor more directly analogous to OTAs for the properties included in the program.

Like Priceline, almost all of TripAdvisor’s revenue is derived from helping travelers find hotels – it does sell banner ads, some of which are purchased by providers of other travel services and attractions (Exhibits 7-8). Like Expedia, the majority of their sales are booked in the US (52%), with EMEA most of the rest (32%).

Exh 7: Trip Advisor Annual Revenue, 2008-2015

Exh 8: TripAdvisor Sources of Revenue, 2013-15

The Middleman’s Middleman

Global Distribution Systems sit between airline reservation systems and OTAs/agents, enabling schedules, fares and availability to be compared across carriers and for multicarrier itineraries to be booked and managed (Exhibit 9). The master passenger record (PNR) is kept with the GDS, and each airline knows only of its own flight segments. Originally, all three of the major GDSs were born as integrated parts of the airline’s own reservations systems. Sabre was founded in 1954 as part of American Airlines and spun out as an independent company in 2000. TravelPort is the combination of Galileo, which was a joint venture of 11 airlines led by United and British Air, and WorldSpan, originally founded by Delta, Northwest and TWA. It was brought public in 2007. Amadeus was built by AirFrance, Lufthansa, Iberia and SAS and is the largest GDS. It trades on the Bolsa de Madrid (BME) and is a component of Spain’s largest stock index, the IBEX 35.

The GDS business model charges a commission to the airline on every booking, paying back a small piece of that fee to the OTA/Agency as an incentive to use one GDS vs. another. Because the GDS systems are the primary tool for agents and OTAs to compare and buy flights, most airlines have historically felt compelled to pay the fees and list their seat inventory. Recently, the GDS have pushed to add hotels and other travel services to their systems, moving to siphon value from the OTAs and their dominance of lodging bookings. In addition, the GDSs have looked to leverage their substantial data center, data base programming and OTA/agency reach into selling hosting services for individual airline and hotelier reservations systems. The considerable sunk investment in hardware and software data center infrastructure has also been a substantial barrier to entry for would-be competitors, albeit one that may be less of a barrier going forward.

Exh 9: Travel Distribution Channel Schematics

The GDS industry has been repeatedly accused of oligopolistic behavior by the airlines, with the fees charged (roughly $5-10 per flight leg) and services offered (plain vanilla air fares) largely uncontested across the three major systems. Sabre has generated operating margins of roughly 17% in recent years, with consensus expecting them to bump above 22% for this year and beyond. Sales growth popped to 12.5% in 2015 and is projected at 15% in 2016, largely on American Airline’s acquisition of US Airways and subsequent integration of its reservation activities on to Sabre’s platform. 3 year sales growth is projected to moderate to just over 9% on average over the next three years (Exhibit 10). TravelPort has been growing much more slowly at just 3.5% over the past 3 years and has generated margins of less than 9%. Still analysts expect growth to double to 7% in 2016 and beyond, with operating margins picking up to 15% (Exhibit 11). Amadeus is the largest GDS with some €3.9B ($4.2B) in revenue. It has managed the fastest growth in the space in Euro terms at a 10.4% CAGR over the past 3 years, but 3.5% in dollar terms with the significant downward move in the Euro over the past two years. Consensus expects the company to grow 9.2% in dollar terms and 8% over the next 3 years. With Lufthansa’s move to disintermediate the GDSs, we believe its growth can decelerate (Exhibit 12).

Exh 10: Sabre Key Financials and Estimates

Exh 11: Travelport Financials and Estimates

Exh 12: Amadeus Financials and Estimates

The Airlines Strike Back … Again

The rationale for spinning out GDS businesses was appealing during the height of the bubble era. Airlines were convinced that the travel agent model was ripe for disintermediation, and that the internet would make it easy for interested parties to book directly with their own web sites. Amadeus, Sabre, Galileo and WorldPort could be sold or spun off for a profit, and the new owners would watch bookings through the systems slowly fade away.

It didn’t work that way. Traditional agents were disintermediated, but by OTAs and not direct bookings. Airlines had stopped paying commission to agents, but the GDSs shared a piece of their fees to lock their screens in place at the slowly declining agency channel, while cutting deals with the OTAs to supply their backend computing platforms. In 2004, the US Department of Transportation deregulated the GDS business, freeing them to negotiate terms of business with both airlines and OTAs/agencies. These orphaned businesses, once thought to be long term declining cost centers, had become unavoidable middlemen, collecting fees that were double the airlines’ net profit margins.

So the airlines have tried to push back. Some tried lawsuits – American Airlines inherited a major unresolved antitrust action against Sabre when it acquired US Airways – but thus far world courts have been unwilling to rule in their direction. Some have been defiant – Southwest has been successful in refusing the GDSs and requiring direct flight bookings – Others? Not so much. Lufthansa is trying to pass the commissions through to its customers, levying a 16 Euro fee for all flights booked via GDS rather than directly. Many have created incentives for frequent customers to book directly, offering bonus miles, promo code discounts, and other free perks. So far these efforts have had modest effect, with consumer-focused travel agents beginning to shift toward direct booking in order to offer more differentiated and price competitive services to their customers.

However, change could accelerate. With the acquisition of US Airways, American Airlines completed a 10 year run of industry consolidation that leaves us with four major airline groups (American, Delta, Southwest and United) controlling more than 85% of the market share in the US (Exhibit 13-14). The deals between the airlines and GDS’s typically run for 3-5 years and prohibit the carriers from listing lower fares through alternative channels. The beefed up airlines will look to drive greater flexibility in their next iterations, with more latitude to offer better deals to passengers that book their tickets directly. It is also possible that the powerful OTAs could look to cut out GDS partners and cut their own deals directly with airlines (Exhibit 15). Airlines have also become better in operations and for the first time in their history have been consistently profitable. After the great 2008-09 recession, they’ve cut capacity and along with industry consolidation are operating at ~85% load factors. Load factors are a measure of revenue paying passengers and don’t include non-revenue passengers like mileage award tickets and airline employees flying for free. The airlines are unlikely to concede distribution fees when they are operating at full capacity (Exhibit 16).

Exh 13: Airline Consolidation in the US, 2001-2015

Exh 14: Domestic Airline Market Shares by Passenger Traffic and Revenue, 2015

Exh 15: Global Distribution Channel Share Shift, All Airlines 2012-2017

Exh16: U.S. Airline Load Factors and Available Seat Miles, 2002-15

Hoteliers are Also Flexing Their Muscles

At first, OTAs were a good way for hotels to sell off unreserved room inventory. The marginal cost of a room-night is pretty low, so filling the room on short notice, even at a substantial discount was a net positive transaction. This worked pretty well, as long as the volume of business flowing through the OTAs didn’t cannibalize sales through more profitable channels. Whoops.

Hotels are a fragmented market, complicated further by the relationship between the investment groups that own the hotel properties and the hotel brands that manage them (Exhibit 17). Real estate investors may own multiple properties within a single market under multiple brand groups. A hotelier may brand and manage multiple properties in a market, each with a different owner. While both investor and manager have incentive to generate revenue for a particular hotel, their motivations to maximize their broader interests may diverge. This weakens the negotiating position of the hoteliers vs. the OTAs, a reason that commission rates on room bookings are often 20-30%.

Exh 17: Major Hotel Operators and Acquisitions

This could also change. Like the airlines that preceded it, the hotel industry is beginning to consolidate. Starwood has agreed to be acquired by Marriott, with increased leverage in negotiations with OTAs an explicit and important part of the rationale for the merger. The French Accor Hotels acquired Fairmont Raffles. Intercontinental Hotels Group bought Kimpton. Wyndham acquired Dolce. All of these transactions were initiated in 2015, with more consolidation expected in 2016. There are 16 different hotel companies that have at least 500 properties under management, plus several luxury nameplates with dozens of high revenue locations. According to TravelClick, the branded hotel chains have been able to grow their share of bookings through their channel from 27% in 2013 to 35% in 1Q 2016 (Exhibit 18).

Some of these buffed up hotel companies have begun to fight back. Hilton Hotels has launched a program offering 10% discounts for its HHonors loyalty program members who book on its website. This program has been supported by a national ad campaign launched during the 2016 Grammy awards telecast, featuring the slogan “Stop Clicking Around” and urging travelers to book directly. Loyalty program rewards are key incentive levers for the biggest hotel chains in their moves to bypass OTAs.

Like the GDSs, the OTAs are also feeling pressure from anti-trust regulators, particularly in Europe where Priceline’s Booking.com settled a grievance brought by hoteliers in France, Italy and Sweden last year. The settlement, which allows hoteliers to hold back room inventory from the OTAs, to offer rooms at different prices through different online agents, and to offer cheaper rates to consumers directly through non-internet channels, is expected to be a template for other markets and OTAs in Europe. While the agreement still restricts hotels from advertising lower rates on their own websites, it opens opportunities for new OTA entrants to compete with lower room rates and lower commission rates.

Exh 18: Share of Hotel Rooms Sold By Channel, 2013-16

Hotel, Motel … AirBnB

In 2015, AirBnB booked about 80 million room nights for a total value of around $7B – doubling its totals from 2014 despite its ongoing battles with local governments over its business model. While this is still less than 1% of the global hospitality industry, the extraordinary growth rate has hoteliers on notice. McKinsey has estimated that the company could grow to $80B in bookings by 2020, which would top both Priceline and Expedia. In a hospitality industry expected to grow only just ahead of global GDP, $70B in new AirBnB revenues would represent the lion’s share of market upside (Exhibit 19). Obviously, this is a big concern for hoteliers and, by extension, the OTAs.

To date, Priceline and Expedia managements have downplayed the threat of AirBnB, suggesting that its model of managed private rentals has limits to its appeal for most travelers. Expedia is dabbling in the private rental market with its HomeAway initiative, but seems believe that it has time to build that business organically. We see it the other way, believing that having reached critical mass of both travelers and owners, AirBnB is primed to attract swaths of share from the traditional hospitality market, and is already seriously truncating demand in major markets during peak occupancy. This will significantly dampen growth from the OTAs most profitable segment, and raise pricing pressures for hotels, and, by extension, on the OTAs. With a private valuation of nearly $25B, the opportunity for OTAs to acquire AirBnB is likely gone.

We believe that the effect of AirBnB will show in greater than expected sales deceleration for both Priceline and Expedia over the course of 2016 and beyond. We also expect that its presence will also increase the resolve of hotel groups in future commission negotiations, potentially pressuring margins lower.

Exh 19: AirBnB Nights Booked and Revenue

The New Guys

Historically, the massive data center infrastructure necessary to run a Global Distribution System or an OTA has been a huge barrier to entry. However, the dramatic price cuts from the leading public cloud hosts – Amazon Web Services, Microsoft Azure and Google Compute Engine – have opened the door to a wave of new competitors willing to undercut incumbents on price while attacking their unwieldy interfaces and inflexible software architecture. The airlines are more than willing to help, having standard XML interfaces to their reservations systems available for the fledgling market entrants. According to CB Insights, 360 travel tech deals were placed in 2015, raising a total of $5.4B, more than doubling the money invested in 2014. Of these, 52 specialized in travel booking, and raised more than $650M, not counting AirBnB’s $1.5B placement. These new players have had minimal impact over a short time thus far, but have the potential pressure incumbents on price, market share and on their investment in addressing their architectural shortcomings (Exhibit 20).

Exh 20: Travel Tech Financing History: Deals and Dollars, 2010-15

All three of the major GDSs – Sabre, Amadeus and WorldPort – were spun out from the legacy reservation systems at the airlines, and all have struggled to modernize the architecture of the infrastructure and applications. The inflexibility of the structured data base records required by the GDSs also creates a substantial opportunity for entrants with systems able to manage individual flight legs separately within an opportunity, to broker the sale of ancillary flight products (upgrades, baggage allowances, special meals, etc.), or to do easy total cost comparisons of alternative itineraries.

OTAs also have vulnerabilities. TripAdvisor’s Instant Bookings leverages those 350M unique monthly visitors. Prominent slots on travel search pages are reserved for these listings, which execute one-click purchase directly from TripAdvisor, rather than linking the customer to the ad buyer’s site. Instant Bookings are paid on a commission basis, rather than on the typical cost-per-click model, with the average cost roughly 12% of the value of a booking. This is a good deal for hoteliers, which can pay anywhere from 10-30% commission on rooms booked through OTAs.

Exh 21: Share of Digital Travel Bookings by Device Type

The 800 Pound Gorillas

Travel inquiries are one of the biggest and fastest growing searches on Google, jumping 50% in 2015 for searches from mobile devices (Exhibit 21). In that context, Destinations on Google, launched in early March, could be a significant new competitor for both OTAs and GDSs. Entering the word “destination” after a place name in a search query now returns a special page with an array of travel planning tools, including easily parsed flight and hotel pricing information, and trip budgeting capabilities. While OTAs and GDSs are free to buy advertising on the service and contribute their listings, the primary links are a powerful route for airlines and hoteliers to induce travelers to book their flights and accommodations directly. The initial launch was quiet, but broader promotion of the capability is likely forthcoming.

We also suspect that Apple could also begin offering tools for iPhone users to book travel directly with the service providers. The Passport App already manages electronic tickets and hotel room keys, while Apple Pay is pushing to encapsulate loyalty program cards. Integrating these capabilities into a travel planning app that allows its loyal user base to shop for flights and rooms, pay for them and manage airline/hotel loyalty programs with Apple Pay, and, then, organize the travel documents and manage the itinerary with Passport, seems an obvious next step, particularly given Google’s move.

Amazon already made a play for the OTA market, launching Amazon Destinations as a trial with travel listings in the Pacific Northwest and Southern California in April of last year before abruptly shuttering it six months later. Amazon has given no explanation for its short lived trial. While it may be that Bezos and company have simply moved on to other opportunities, the $1T addressable market and the high margins of the OTAs must be very tempting, particularly given the advantages of Amazon’s customer reach and loyalty. We suspect that Amazon was not happy with the particular implementation of its Destinations product, but would not be surprised to see it re-enter with a revamped and perhaps, even more comprehensive offering. It followed a similar pattern in the B2B wholesale space, where it began with an acquisition and a limited trial, followed by the launch of the Amazon Supply service, which was closed and subsequently relaunched as Amazon for Business.

All of these platform plays would allow airlines and hoteliers to reach around the GDSs and OTAs to reach customers directly, and while this access wouldn’t be free, we believe that at least Google and Amazon would offer significant discounts vs. the status quo to drive the business forward.

Exh 22: Indexed Travel Tech Stock Performance, YTD

It’s the Economy, Stupid

The combination of a slowing Chinese economy, unstable energy markets and a brewing European political crisis have had equity markets on tenterhooks. An end of summer tumble was followed by a more substantial January sell off, which was particularly unkind to high growth, high multiple tech stocks. Curiously, the OTAs and GDSs have held up, with Priceline, Sabre and Travelport trading flat or slightly up since August and YTD, Expedia down about 12% this year, with TripAdvisor the one serious underperformer, down almost 25% in 2016 (Exhibit 22).

Exh 23: US Travel Spending, 2004-2014

Historically, travel spending has suffered disproportionately during recessions. US travel related spending was off 8% in 2001 and over 10% in 2009 (Exhibit 23). The emergence of terror threats in Europe may also have a damping effect on travel in the upcoming summer season. Meanwhile, consensus projects Priceline, Expedia, Sabre and TravelPort to accelerate their sales growth in 2016. All of this points to travel tech stocks, with the possible exception of TripAdvisor, having significant risks that are not yet embedded in share prices.

The Final Itinerary

While the Global Distribution Systems have built impressive competitive moats with their infrastructure investments, dominance of the corporate travel channel, and most favored nations clauses, we believe that the deterioration of their oligopoly power in the distribution of airline tickets is inevitable. High commission fees and falling competitive barriers have spurred alternatives – direct sales from the recently consolidated airlines, cloud-based startups, and platform-based tools – that we believe will capture a significant share of the airline ticket sales currently flowing through Sabre, Amadeus, and TravelPort. Moreover, the effect of an economic recession would likely be disproportionately harsh on travel bookings, and thus, on the GDSs.

The same structural risks hold for Online Travel Agents, who have built a similarly impressive oligopoly position in hotel bookings. Here the threats from hotelier consolidation, startups, and convenient platform integrated tools are joined by the specter of AirBnB, which has already siphoned off a meaningful share of hospitality industry growth and threatens to drastically squeeze OTA addressable sales in the future. We believe that growth and profitability estimates for Priceline and Expedia do not adequately address these risks, or the vulnerability of their businesses to a potential economic downturn (Exhibits 24-26) .

TripAdvisor – with large regular user base and user-generated reviews, advertising driven revenue model, and Instant Bookings opportunity – is likely to prove much more robust to the structural changes that threaten the GDSs and OTAs. Moreover, its business model is an interesting fit for the platform players – notably Google and Amazon – who have shown interest in the travel market. In this context, we see consensus expectations of decelerating sales with modestly improving margins as more achievable, although its 32x forward P/E multiple is far richer than its OTA cousins.

Exh 24: Priceline Key Financials and Estimates

Exh 25: Expedia Key Financials and Estimates

Exh 26: TripAdvisor Key Financials and Estimates

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