Travelzoo: Still Looking Good For The Future

Travelzoo has seen a rising tide of interest over the last few months based on stronger than expected Q3 results, the launch of Local Deals and most recently with Google’s failed attempt at acquiring Groupon for $6Bn. While the Street has become more aware of TZOO as a result of these events, the Company is still generally viewed as an expensive comp of Priceline or Expedia, when they are in fact more of a comp to a hybrid of google and a newspaper due to their dependence on ad revenue, but their revenue and margin growth that is derived from greater circulation.

As a result of these comps and a misunderstood business model, the Street seems to view TZOO as overvalued. Short interest in TZOO over the past few months has grown substantially as a raw number (990K shares on 10/15 to 1.6MM shares on 12/31), although much higher trading volume since last quarter's earnings has lowered the days to cover the short position.  With only two analyst estimates of $0.18 EPS (Wedbush) and $0.22 (Craig Hallum) for Q4, TZOO should beat these estimates handily, which may force another wave of short covering like that which pushed shares up 18% the day of last quarter’s earnings report and almost 70% since that report.  Based on my estimates, I believe shares are actually trading at a more reasonable 20-25x 2011 EPS as Local Deals and a profitable European business should help fuel additional EPS growth.

Business Description

Travelzoo is a global media company with distribution to over 21 million subscribers worldwide as well millions of website users each year. Their core product is an e-mail service that alerts travelers about special deals on flights, hotels, rental cars, etc. They also operate fly.com, which is a travel search engine similar to Expedia or Kayak (though this is a small part of their business currently).
The Company’s main source of revenue is ad sales in North America and Europe via their websites as well as their e-mail newsletters. This past summer, they began to capitalize on the daily group buying phenomena by creating ‘Local Deals’, a service that runs short term Groupon-style deals with big discounts on local restaurants, attractions and services.

Local Deals

While the Street has clearly recognized some of the revenue potential from the daily deal space, Groupon-like deals are still a relatively small amount of TZOO’s revenue, but have been growing exponentially, with significant upside yet to be realized. Since launching their Local Deals in a few test markets in July, TZOO has sold north of 150K deals through their website and earned gross revenue of over $8.4MM. Although it is hard to gauge exactly what the revenue share is on TZOO deals, marketplace comps would indicate around 40% of gross revenue goes to TZOO top line.

Although Q3 only included a handful of cities and not even so much as an advertisement for Local Deals on the main homepage, TZOO managed to sell over 22K deals for north of $750K in gross revenue (~$300K net).  Since launching to several other cities in Q4 as well as making it easier to find the Local Deals page (and some PR), they have sold ~$7.6MM in gross revenue, leading to ~$3MM of additional revenue to TZOO (at 40% revenue share).  Because the Local Deals are a high margin product and don’t require a large sales force, around 75% of this revenue makes it to operating income (due to the frequency at which TZOO is currently running deals, a large sales force is not yet required, though this would change as they grow and may impact operating margins). At a conservative tax rate of 38%, this should mean Local Deals will add ~$1.4MM, or $0.09 EPS.  The below data can all be found via TZOO's website for Q4:

DEALS
Oct. – 35,346 Deals
Nov. – 46.441 Deals
Dec. – 59,357 Deals

GROSS REVENUE
Oct. - $1,528,920
Nov. - $2,801,644
Dec. - $3,394,431

Today, TZOO is serving 27 markets, and has annualized gross revenue of $16.8MM in Local Deals, although I believe that it is not out of the question that TZOO could earn as much as $30-40MM in 2011 revenue on Local Deals. The keys for 2011 are going to be: 1) launching to several more large cities in both the US and Europe, 2) higher ASP/deal, 3) running deals more than the average of once a week for large markets and once every 2-3 weeks in smaller markets.

I believe it will be no problem at all for TZOO to be in 25 large markets (13 now) and 25 medium/small markets (14 now) by the end of this year.   In fact, they have already launched to 5 new small markets in January alone and I would expect 2-3 large city launches in the next 6 weeks. By simply hitting the first tier US cities in which it does not currently operate (Atlanta, D.C., etc.) as well as several large European centers (Paris, Barcelona, Munich, etc.), this will be no problem at all.  TZOO is in fact already hiring for Local Deals managers in several European cities as seen here. What is also very smart about TZOO expansion strategy is the hub and spoke model they seem to be employing.   For example, Miami was the first major city launch in FL and from there Orlando, Tampa, Jacksonville and Ft. Lauderdale have followed.  TZOO launched London right before Christmas and just launched Gloucestershire this week...likely places such as Liverpool, Manchester, Leeds, etc. will follow.

The second goal is going to be to increase ASP/deal. For example, Q4 ASP (excluding the December 99 hour special) was ~$60.50. There were several higher priced deals that sold very well during the quarter as well as a number of large city additions, which pushed this average above the ~$35/deal average in Q3.  While a growth in cities and an ASP consistent with Q4 will guarantee earnings growth, to push TZOO to become a portfolio double at this point, ASP is going to need to grow substantially.

A good way for this to happen would be moving into more high priced travel deals such as Living Social is doing now in their LS Escapes or Gilt's Jetsetter.

Finally, TZOO certainly has the ability to run more than one deal a week; whether they end up doing it is another question. For conservatism sake, let's assume they stay with an average of 1 deal per market, per week and look at the economics for 2011...

If Local Deals was to expand to 25 large and 25 small markets by FY2011 at it's current ASP, economics would be as follows (Realize that markets will be added throughout the year, so some markets will not have full year of revenue...i have remained conservative to compensate by keeping ASP and number of deals run conservative):

50 (cities) x 52 (1 deal/wk) x $60 (ASP) x 500 (coupons sold/deal) 40% (Revenue share) = $31.2MM in net revenue to TZOO

$31.2MM x 75% (Op Mgn) = $23.4MM Op Income

$23.4MM x 38% tax rate = $14.51MM Net Income or $0.88 EPS

On an important note, at $75 ASP, Local Deals is worth $1.10 EPS in 2011

At a conservative 25x multiple on these earnings, Local Deals is worth between $22-28/share

Core E-mail Business

The e-mail distribution business is still Travelzoo’s bread and butter and where they get the majority of their earnings. With over 21 million subscribers worldwide, TZOO’s distribution list is a powerful advertising tool as well as a good barrier to entry against all but their largest 'competitors'.  As of Q3, TZOO earned annual revenue of about $6.20/subscriber in North America and $2.83 in Europe. Historically, TZOO has been able to acquire NA users at a substantially lower price ($1.60 in Q3), while European subscribers have averaged around $3.70 over the last twelve months ($2.90 in Q3).

TZOO management has been very focused on growth of the European market and as such, costs have been higher in the past several quarters; however, Q3 marked the first time that the European business generated a profit for TZOO as users reached critical mass and both sales & marketing as well as G&A costs were controlled. Over the past 7 quarters, TZOO has added 300K net users in Europe each quarter and with their push for growth in Europe, there is no reason to believe this cannot be repeated in Q4. Assuming around 4.5MM European users in Q4 with higher sales and marketing costs (but lower as a % of revenue) and G&A roughly in line from Q3, the Europe business should earn around $7MM in revenue and $1MM of income from operations. Along with conservative net user growth of around 140K in the NA region, TZOO should earn almost $29MM in revenue from core operations for Q4.

European user acquisition costs tend to be difficult to predict from quarter to quarter as they differ according to markets all over the EU, but the general trend should be +/- flat or lower as TZOO gets larger. Generally, as an organization grows, it gets easier to acquire users and the cost should decrease as a function of click-thru and signups. Think Facebook vs. internet startup, Facebook’s brand recognition helps derive a higher click-thru rate and more people are likely to end up signing up as users. Under this assumption, Europe’s user base growth and lower user acquisition costs should help grow operating income and produce results at least in line with last quarter. My estimate is the core e-mail business should conservatively earn around $23MM in operating income in 2011. At the assumed 38% tax rate, this will result in ~$1.40 of 2011 EPS. If we apply a 20x multiple to these earnings, the core e-mail business is worth about $28/share.

In addition to the normal earnings growth of core e-mail, I could see a scenario in which the more viral nature of the daily deal product could result in core e-mail user growth above the normal rates that TZOO has experienced in the past. This could result in a higher multiple being applied to core e-mail earnings as well.

Based on the conservative assumptions above, TZOO shares are currently slightly below fair value based on a 22-23x multiple applied to earnings. If shares trade at a growthier multiple, legitimized by much higher ASP or greater growth in core e-mail, shares have significant upside from here. Either way, I believe this quarter could be a blowout for TZOO and give the Street notice to the earnings power of Local Deals and TZOO as a whole.

Risks to Thesis

1. Significantly higher user acquisition costs would cut into margins. According to how many users are added and how other costs are controlled, this may or may not have a major effect on earnings. This is somewhat mitigated by the general rule that standard user acquisition costs should decrease as TZOO gets larger and has more brand recognition. Either way, unless acquisition costs are grossly higher, an EPS beat should still be achievable.

2. If Local Deals fails to grow past its current distribution or if the daily deal phenomenon loses significant steam, TZOO may not meet my forecasts in 2011. Lower ASP would also negatively affect the thesis.  This is mitigated by the higher ASP in Q4, which has sustained in Q1 thus far as well as avenues of higher ASP growth such as travel packages.

3. A double-dip recession, significantly weaker economic environment or a terrorist attack/threat that causes airline and leisure travel to slow significantly would likely cause shares to trade down despite potentially little effect to the underlying ad-revenue based business.

Other Items/Conclusion


While they provide additional positives to the thesis, I have left out the financial metrics of growing cash flow and a strong, debt-free balance sheet, the Company's ability to re-acquire the licensed Asia business which was sold in 2009 and any upside provided by Fly.com as those are less important to TZOO as a whole (currently, at least) than the new Local Deals vertical. Based on the core operating model as well as the newly launched Local Deals vertical, I believe that not only will TZOO significantly outperform analyst estimates for Q4, but has significant growth potential going forward.

Disclosure: Author is long TZOO

Daily Deal updates

I've gotten a lot of questions about sharing data on TZOO and OPEN since I posted my articles several weeks ago on my blog, so I wanted to provide a brief update.  I was cautious on both TZOO and OPEN due to their enormous runs prior to my posts, although I had taken a small position in TZOO to get a play on the deal hype at a significantly cheaper valuation (there was more analysis than this, but for simplicity sake, let's leave it at that).  At that time, I was more impressed with the deals and the promotion I had seen out of OPEN as they had quickly ramped up their high-end restaurant offerings to a number of cities and had been expanding their city base at the rate of about 1 new city per week.  They also started sending spotlight deals to anybody that was registered on their OpenTable website to help grow the offering by word of mouth.

As of a month ago, TZOO had been lagging pretty substantially.  They were offering new deals very sporadically, running in only a few markets where they had not been selling very impressively.  It was also nearly impossible to even find their "local deals" on their website homepage (www.travelzoo.com).  While the local deals service was highly complimentary to their existing travel offerings, they were not promoting it well and it wasn't exactly "snowballing" very fast.

What a difference a month makes!  About a week after I wrote the two articles, I spoke with another analyst that was more bullish about TZOO and their offerings; he got me thinking more about the value proposition that TZOO offered and their ability to grow above and beyond the purely restaurant offerings that OPEN brought to the table (no pun intended).  I maintained, and still do, that it will be tough for OPEN to widen their offerings past higher end restaurants, but what I had not considered as thoroughly is whether diners would get high-end restaurant fatigue.  Although still too early to tell definitively, with 8-12 full weeks of data from many OPEN cities, it appears this may be the case.  In every city where spotlight is offered, except NYC, the average revenue/week has been dropping since they started offering deals in the city (all spotlight deals, except one week in Chicago, have been $25, making the data easy to track).  Several cities have dropped sequentially every week since spotlight began, with the losses between week 1 and the current week being between 30 to 40%.

In the meantime, TZOO has gone on a complete assault on the daily deal space, launching to several new cities and having blowout week after blowout week.  With an e-mail distribution list that boasts over 22 million subscribers, not only are people used to getting e-mailed by TZOO, they are now becoming more familiar with the daily deal space as the Groupons and Living Social's of the world become more well known (anecdotally, my mom asked me if I had "heard about these Groupon things" the other day, so the word has officially gotten out).  TZOO has also been offering a wide array of deals, similar to Groupon...everything from Mani/Pedi deals to indoor skydiving and wine & cheese classes.  Because of the price lumpiness of TZOO deals, it's not as easy to get an average deal stat, but there has been noticeable growth in the very successful deals (those selling +$50K gross revenue).

What has this done for TZOO from a revenue perspective?  Since their first deal was offered in Des Moines on July 29th through the end of Q3, they sold ~$850K (gross rev.) of deals.  Through not even three weeks of Q4 and into several more cities, they have made over $1MM in gross revenue with seven deals grossing over $50K each.  It will be an ongoing experiment through the rest of the quarter to see how many more cities they launch and if the deals keep selling as well as they have been, but the first few weeks of Q4 have been extremely encouraging, to say the least.  From a valuation and (less) hype perspective, as well as an offerings and distribution perspective, I still believe the best way to play the trend in the daily deal space is TZOO.  If they can continue at their current rate in just the cities in which they currently operate, assuming a 30% net margin, TZOO should have an additional $0.10-0.12 of EPS for the quarter.

Disclosure: Author has a long position in TZOO; no position in OPEN

OPEN: Update On Daily Deals

As a follow up to my previous article on Travelzoo (TZOO) from Monday, Sept. 13 (which is up +25% as of writing), I put together some recent deal data for OpenTable that I think is pretty interesting.  Getting a little more detailed on the deal services each company offers, Travelzoo has a much more erratic timing on their deals, they may last 3 days or 1 week according to whatever hurdle they are trying to clear on sales, which is unclear and the Company is notoriously hard to reach (I even spoke to one of the few analysts that cover them and he said he communicates mainly via e-mail with IR).  TZOO deals tend also to be lower end ($10 of cupcakes on TZOO vs. $25 off at Gordon Ramsey restaurant on OPEN).  Thus far, OpenTable has had a more stable one deal a week schedule that tends to be at higher end restaurants and all have sold very well.  See below:

During the first week of launch in a new city, activity tends to be very strong, which has been no different in D.C. this week, where OPEN sold 1,992 deals in the first week.  What is most encouraging in their data vs. TZOO is how many deals they are selling and the consistent price point.  TZOO, while having done daily/weekly deals since mid-July, has managed to sell approximately 12,000 deals at prices from $10 to $99, while OPEN, having just launched it's first deals in NYC and Boston in early August, has managed to sell well over 26,000 deals at an average price of ~$25, netting them almost $700K gross additional revenue in a month and a half, in only 7 cities.  The reason I have harped on this again after only one week is that they have only launched in 7 large markets (netting an annualized gross revenue of ~$5.4), while there are probably an additional 20 or more markets that could easily bring in these number of deals each week if they can maintain the quality of restaurants and another 30 in smaller markets that could bring in 1/3 as many deals.  

While you may look at this as a skeptic and say the market is crowded and there are 200 daily deal guys out there offering a similar service/product, I would retort that there are not many that are peddling the high-end like OPEN and there aren't any that have the same diner brand recognition, restaurant relationships and distribution that OPEN does in this particular space.  If you're still skeptical and you think the fad will go away, ask yourself: if you got a 50% off deal one week for a favorite restaurant nearby, then the next week you got a similar offer from another restaurant you really like, would you pass on the second one and say, 'nah, I already saved money last week, no reason to do it again'.  Of course not...recession or not, people like to save money and you'd buy a deal every week if you were presented with quality, desirable restaurants and that's what I believe OPEN aims to do.

Since I published this piece originally on Friday afternoon to my Blog, Barron's came out with a full story over the weekend regarding the rich price of OpenTable shares.  The piece makes several good points that have been harped on by every short seller or naysayer on the stock, mainly that it's expected growth (or lack thereof) does not justify it's high multiple.  Barron's says, "it's valuation, at 110x this year's estimated earnings of 59 cents a share, and 75 times next year's forecast of 87 cents, could lead to sever indigestion."  While I don't disagree that it may be time to take some profits off the table if you own and probably not the best time to get in if you do not, the article neglects to properly highlight the basis for the recent moves in the shares - the Spotlight deals.  With only one brief mention towards the end of the piece, Barron's doesn't seem to grasp the growth potential of this new revenue source.  

I'll leave the conversations of valuation to another forum (expensive for my blood given the recent run up), but keep in mind that if they can earn $5.4MM gross revenue on 7 cities, what happens when that is 25 cities or 50 cities?  Below is a conservative snapshot of the impact of daily deals for this year (2 cities, ramping to 14) and 2011 at only 25 cities.

Disclosure: Small Long position in TZOO, no position in OPEN

TZOO: Still more upside from daily deals

As many of you know, there is a phenomenon known as Groupon that has been sweeping the nation and is now moving into other countries as well.  For those unfamiliar, what Groupon does is negotiate one really great deal in your city each day at a huge discount (normally 30-90% off) and send it to you in a nice morning e-mail.  These deals may be for local restaurants, spas, or fun activities.  Along with Groupon, which is in over 100 cities, there have been many copycat services like LivingSocial, BuyWithMe, etc.  (Shameless plug: a couple of friends run a great site called Yipit.com that aggregates all of these daily deals in several cities and sends you ones based on preference of the types of deals you like, go sign up)

The business model is not too difficult to set up as long as you have some tech savvy to create a website and can devote the time of at least one person to pound the pavement and find businesses that want to do the deals.  The businesses win because they get new customers they may not have otherwise gotten, the Groupons of the world win, because they get a cut: 50% of the face value of the coupon.  That's right, 50% for negotiating the deal and posting it on a website.

I'm simplifying it quite a bit, but the bottom line is that it takes very few bodies to get the deals negotiated and the margins are HUGE.  Past paying people to find deals and keeping the lights on, the cost structure is not very burdensome and you can make a ton of money, which is why recently, Groupon raised a round of venture capital that placed a $1.35Bn valuation on the company (see techcrunch.com/2010/04/18/its-official-groupon-announces-that-1-35-billion-valuation-round/)...that's right, BILLION.  According to stats, Groupon reaches around 18 million people via their daily e-mail. and has over 100 deals running a day.

As I said, the low barriers to entry have brought a lot of entrants into this space and now a few publicly traded companies have gotten into the peddling of daily deals as a new revenue source and to reach additional customers that may use the site for other reasons once they are there.  Travelzoo (TZOO), OpenTable (OPEN), and The Knot.com (KNOT) are the notable entrants that have launched in several cities.  While they have only been in this business line for a month or so, their results have already proven very compelling and the stock prices of TZOO and OPEN have subsequently shot up, with BofA-ML recently upgrading OPEN based primarily on their daily deal revenue that will be coming in.

While I think OpenTable has a great business and I use the site frequently, their valuation and reach makes them less compelling to me than Travelzoo, which already has a daily e-mail that reaches +21 million people around the world on a daily basis to hoc travel deals.  The TZOO daily deal is different though...instead of a flight or a hotel that is available for several weeks or months for a discount rate, the daily deal is a one day, huge savings coupon for a specific restaurant, spa, activity, etc. deal.  They currently offer the daily deal in 6 cities (SF, LA, Houston, Chicago, Minneapolis, and Des Moines(!?)) and have done well with the deals they have offered so far, selling several hundred in each city.

Here is why I think it's a game changer for them and why you, as an investor can take advantage of information that is new enough that I don't think most of Wall St. fully understands just how big this could be.  Below are the stats for recent deals on TZOO.  As you can see, there are several deals in a couple of the cities and one deal in a few of the newer markets.  For conservatism sake, I have assumed that TZOO has not gotten as good of a revenue share deal as Groupon and only gave them 30% credit for the face value of the deals, but as you can see, the revenue is material to a company that is this small when you consider they will potentially do lots of these deals each quarter going forward...and they haven't even launched in NYC, Miami, Philly, Dallas, etc.  If they can make this much in a market like Des Moines, imagine what they could do in larger 2nd tier markets like Cleveland, Tampa or San Antonio for instance.

Example Deals
Des Moines	Deals Bought	Deal Value	Total $ Sold	TZOO Revenue*
Deal 1	125	$10	$1,250
Deal 2	107	$10	$1,070
Deal 3	65	$14	$910
Deal 4	25	$10	$250
Deal 5	48	$15	$720
Deal 6	717	$20	$14,340
Deal 7	358	$25	$8,950
Deal 8	196	$10	$1,960
DM TOTAL			$29,450	$8,835
Chicago
Deal 1	419	$50	$20,950
Deal 2	970	$59	$57,230
CHI TOTAL			$78,180	$23,454
Minneapolis
Deal 1	500	$40	$20,000
Deal 2	1,326	$10	$13,260
Deal 3	1,217	$39	$47,463
Deal 4	1,055	$10	$10,550
MINNY TOTAL			$91,273	$27,382
Houston	112	$59	$6,608
LA	472	$89	$42,008
SF	99	$25	$2,475
OTHER TOTAL			$51,091	$15,327
TOTAL				$74,998

 *Assumes TZOO makes 30% of deal face value

Assuming TZOO does not roll out to any additional cities for the remainder of this quarter and giving them credit for this amount of revenue for ONLY 20 DAYS a quarter (this is a rough approximation, but fair for conservatism in my mind), TZOO could earn an additional ~$1.5MM in revenue per quarter (~5.5% growth over what they earned in Q2), but the best part is the margin on this revenue should be extremely high going forward as it takes so little manpower compared to the rest of their business to get these deals negotiated.

As an added bonus, given that TZOO already has a sales team that is focused on getting local travel, entertainment and hotel deals for their main service, ramping up this service in other cities should be relatively easy...heck, Groupon is launching in about 1 new city a week at this point.  Going forward, TZOO will roll out to more cities domestically with more deals.  International is an enormous opportunity as well, with many Western European cities just recently getting on the daily deal bandwagon.  If only a few deals and a few cities can grow revenue this significantly, imagine what could happen in coming quarters when they have 10-20 cities and more deals running simultaneously.  That 40x P/E multiple they currently sport could drop to a meager 15-20x when the E grows.

Disclosure: No position at this time, but evaluating a long in shares of TZOO