From briefing.com -
Priceline's Predicament
20-Sep-99 00:44 ET
What if priceline.com (PCLN) got into the online brokerage business? If it happened, you would have the opportunity to "Name Your Price" for PCLN stock. Here's the catch -- you would have to name your price without knowing the current market price for PCLN. You guess too low and it's no deal. Guess too high, and it's yours. Such a bargain! That's the PCLN business model -- "Guess The Price." It's a model whose profitability is dependent on the consumer overpaying. You wouldn't do it for the goods/services that PCLN sells, so why do it for their stock?
Priceline.com likes to think of itself as the company that will eventually let you name your price for anything and everything, just as Amazon.com wants to be the company that will name its price for every imaginable retail item. That is how -- even after falling over 60% -- it can still fetch a valuation of over $8 bln.
But the reality is much different. Priceline.com has two distinct businesses; we'll call them perishables and nonperishables. In the perishables category are priceline's core businesses -- airline tickets and hotel rooms. We call these perishable because the services for sale are worthless after the flight leaves or the bed goes empty for the night. In the nonperishables category are cars and mortgages. Neither of these items perishes after a set date. Ultimately, priceline.com will find that its model is only applicable to perishables, and even then many questions remain.
Perishables
In the market for perishable goods, priceline.com came close to identifying one of the revolutionary advantages of ecommerce. In the market for perishable services, the seller benefits from selling soon-to-be perished services at just about any price if he can do so without sacrificing his existing price structure.
The Internet makes such sales possible. The solution is to auction unbranded airline and hotel services at the last minute. By not revealing the brand and by making the buyer accept uncertainties that most business travellers could not accept, the sellers defend their pricing structure while unloading excess inventory. The key to the long term success of such marketplaces for perishable goods and services is that they both preserve existing price structures and offer both parties in the transaction a more efficient method of distributing the perishable items.
Failing The Consumer
Priceline.com passes the first test but fails the second. There is no question that PCLN's business model largely defends the existing price structures in the markets in which it operates. But priceline.com does not offer consumers an efficient way to buy these services. In fact, the PCLN model is patently anti-consumer. Auctions are fair and efficient, price-guessing is not. Priceline.com offers price-guessing. In our view, the fatal flaw for PCLN is that it depends on consumers for future profits, yet offer consumers no compelling interest to use the service.
The dirty little secret at priceline.com is that you are not "naming" the price for plane tickets and hotel rooms. The price is set in advance. As priceline stated in a recent SEC filing: "When priceline.com receives an offer, it determines whether to fulfill the offer based upon the available fares." Those available fares are posted by the airlines to a private database. As a consumer, you are trying to guess the fares in that database. The best you can do is guess the right price; the worst you can do is substantially overpay by guessing too high.
Priceline.com has of course attracted many customers to its site due to the novelty of its pricing scheme, but we have our doubts about the long term prospects for this model. A far more efficient method of distributing perishables is to auction them. Airlines and hotels would still want to avoid undermining their existing pricing structures, but they could do so via the same strategies employed by priceline: unbranded travel subject to uncertainties about times, locations, etc.
Selling unbranded airline seats and hotel rooms via auction would clear all inventory at the market price. That would be a win/win for buyers and sellers. Consumers would no longer guess the price -- in a transparent auction, they would always know the price needed to make the purchase. And airlines/hotels, instead of parting with the occasional unused seat or room, would actually sell all of their inventory.
When and how will this happen? We have no idea. But markets have a way of gravitating to the most efficient solution, and priceline.com does not have that solution. While it is true that this might not be an immediate threat to priceline, the company's $8 bln market cap is based on optimistic assumptions about the long run, and we're not so sure that there is a long run.
Nonperishables
As for the nonperishable items for sale on priceline.com, we hardly think that these lines of business are worth pursuing under the "Name Your Price" business model. To the extent that there is any value in priceline.com's strategy, it lies entirely in the market for perishable goods and services. In the market for goods and services whose value to the seller is not changing significantly over time, the priceline.com model fails. Here's why.
Let's consider cars, since priceline has recently entered that market. A car dealer has a bottom line price for any car. You might not know what that price is, but you know it exists. It doesn't matter whether you visit your local dealer or "name" the price via priceline.com, which then submits the bid to that same dealer. The dealer will be indifferent to your method, and thus the price that you are trying to guess is the same in either case.
Or at least that would be true if both you and the dealer didn't have to pay priceline.com for its services. The consumer pays $25 to priceline, and the dealer pays an amount that priceline does not disclose in its SEC filings. So in fact, the lowest price that you will pay via priceline.com is quite likely higher than what you would pay if you went directly to the dealer and bypassed priceline!
The only incentive to go through priceline.com is that you spare yourself the trip to the dealer. But then you also take on the priceline.com $200 cancellation risk should you change your mind once the car is delivered. And since you will certainly want to test drive the car before ordering due to that risk, you will already be making a trip to the dealer. So why head back home and guess the higher bottom line price on priceline.com when you could have just bid at the dealership?
This problem is actually much worse in most other nonperishable markets, where there is no uncertainty regarding the price. When prices are set and there is no haggling, priceline.com doesn't stand a chance. Unlike Amazon.com, which truly might sell anything and everything, the markets that might actually benefit from the name your price model are actually quite limited.
Revenues
Not only do we not like the priceline.com business model, but the company itself leaves much to be desired. The games that priceline plays in reporting revenues should be a red flag to potential investors. Priceline.com currently records the full airline ticket price or hotel room rate as revenue.
A travel agent that takes a percentage of a sale from each airline ticket sale does not record the full fare as revenue; it only records its commission as revenue. Priceline.com makes its money when consumers name a price that is above the price that priceline.com finds in its airfare/hotel databases -- that is its commission.
The company defends this practice of claiming the full ticket price/room rate as revenue on the grounds that it is the merchant of record. In other words, you make your check out to priceline.com instead of Delta Airlines. While this trivia might pass muster with the SEC, it should be meaningless in the eyes of investors. The true measure of whether fares/room rate should be counted as revenue is whether or not priceline.com carries inventory of these items and along with it the implicit risk of not selling the item.
And on that score, even priceline readily admits that it does not. A September 10 press release from the company included this line: "Priceline.com does not maintain or warehouse inventories in any of its product lines." And that is of course true. If an airline ticket doesn't sell, it doesn't cost priceline.com a penny. But because priceline.com pays the airline and you pay priceline.com, the company counts the full fare as revenue. What priceline.com records as gross profit ($10.5 mln in Q2) should in fact be seen as revenues ($111.6 mln in Q2).
The market is already aware of this issue and it is therefore partly and perhaps even entirely discounted in PCLN's market price. But we are not comrfortable with a company that is willing to play such accounting games.
$8.5 Billion Or $850 Million?
Priceline.com has done a heckuva sales job on the investment community, there is no doubt about that. By touting its "revolutionary" name your price system, the company has successfully convinced investors that it will soon allow you to name your price for everything. Just as books were only the first step for Amazon, plane tickets were just the tip of the iceberg for priceline.com. But they are not.
Plane tickets, hotel rooms, and perhaps eventually other perishable services like car rentals and cruises are priceline.com's only real markets. And even then, its guess your price service leaves much to be desired versus the auctions that might well take over this space in the long term. But at least there is a meager business for priceline in the leisure travel arena.
But that begs the question -- is a glorified travel agent with a dubious long term business model and questionable accounting practices really worth $8.5 bln? We could more easily make the case that it's worth $850 mln. We may have only just begun to see the downside for PCLN the stock. Go ahead, name your price for PCLN.
Greg Jones - gjones@briefing.com
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