Priceline.com ? 6 October 1999
2
Summary
We continue to believe that priceline.com could become
one of the largest and more successful e-commerce
companies. Although the company?s business model is
still unproven, we believe that it could eventually generate
billions or tens of billions of dollars of annual revenue and
an 8%-10% operating margin. Given the uncertainty
associated with the success of the business and the time-horizon
of such forecasts, PCLN remains an expensive
stock, even in light of its recent pullback.
The fundamentals of priceline.com?s business are still very
strong: if current trends hold, we believe that revenue
could more than triple next year to $1.5 billion (our official
estimate is $750 million). As a result of seasonality in the
airline ticket business, which for a while yet will be the
dominant component of revenue, sequential growth in Q3
and Q4 will likely slow from 100%-plus to about 30%-40%
or so. This will be the result of light seasonal demand
(offers) rather than a lack of supply of airline tickets. The
key value driver of the company is demand growth (fill-rates
will peak around 60%-70%, in our opinion), so it will
be important to see reacceleration in this metric in the
stronger seasonal quarters, Q1 and Q2.
There have been numerous issues surrounding PCLN for
the last few months, including an announcement from
Microsoft of its intention to enter Priceline.com?s hotel
business with a ?name your price? model and concern
about an overhang of insider shares eligible for sale
following the lock up. In this note, we will briefly review
the key points about the business and offer our take on
these issues.
n Proof of concept
The critical concepts underlying priceline are 1) that
consumers will sacrifice the choice of a particular brand of
provider (be it an airline or hotel) in exchange for a lower
price, and 2) that the provider will sell its excess products
or services at a lower price if it can do so without harming
its brand or existing full-price fare structure. Importantly,
over the last few quarters, priceline has offered evidence
that both of these concepts are true.
On the demand side, the company has grown from zero to
2 million customers and a run-rate of $2.5 billion in
aggregate demand (value of the total offers) in less than
two years. On average, consumers also appear to be able
to purchase tickets more cheaply at priceline than
anywhere else?about 25%-50% off the lowest published
fare. Demand growth will continue to be the most
important metric for determining the overall size of
priceline?s market opportunity.
On the supply side, the company is now buying its airline
tickets at prices that it believes are significantly below
those at which the airlines sell to any other distribution
channel, including the deep discounters. What?s more,
priceline now accounts for a meaningful percentage of
some of these airline?s sales and traffic. On TWA, for
example, priceline now represents more than 4% of overall
traffic.
n Forecasting future revenue growth
Priceline.com?s revenues continue to be strongly weighted
toward the travel services segment of the business. Travel
services (airline ticket sales and hotel rooms) accounted
for 92% of revenue in Q2 and we expect this revenue mix
to continue for the next few quarters. Priceline.com plans
to expand both its mortgage business and new car sales but
we would expect it to take a few quarters for these efforts
to make a meaningful contribution to the business. As a
result, investors will likely still focus on the progress of
travel services for a while yet.
Forecasting Revenue. The key driver of priceline?s
growth going forward will be the number of ?offers? the
company receives, whether for airline tickets, mortgages,
cars, or anything else. Much of the company?s revenue
growth last quarter came from a 20 point increase in fill-rates
(essentially a higher utilization of existing demand).
With fill-rates in the airline business now around 45%, we
do not expect to see similar gain in the future (we consider
it unlikely that priceline will ever have more than a 65% or
70% fill-rate, as consumers will keep ratcheting offers
lower until they find the point at which they will no longer
be filled). As a result, we think the best way to forecast
priceline?s long-term revenue opportunity is to make three
assumptions: 1) number of customers, 2) offers per
customer, and 3) revenue (or gross profit) per offer.
In Q2, priceline?s total customer base increased to 2.1
million and the company received about 1 million offers,
averaging around * offer per customer or a run-rate of 2
offers per year. The average offers per customer has
decreased every quarter since the company?s inception and
probably will continue to decrease for a while (as would be
expected as new customers make up a smaller percentage
of the total customer base each quarter?Amazon.com is
experiencing a similar phenomenon). Over time, as the
company adds more products and services and the same
customers come back more often, the ?offers per
customer? should stabilize and then, if the company is
successful, gradually increase.
Our ?aggressive case? estimates, therefore, show a gradual
decline in offers per customer from 2 offers per year to
approximately 1.2 offers per year in 2001, and then, a year
or so later, a gradual increase to 1.5 offers per year. To
arrive at our aggressive-case customer estimate for 2000,
we increase the base by approximately 1.5 million per
quarter?the rate Amazon.com increased its base during a
similar phase of growth. Multiplying the number of
customers times the offers per customer (an average of 1.5
for the year) we arrive at a 2001 revenue estimate of about
$1.5 billion.
As described, the critical component of priceline?s
performance will continue to be the growth of offers.
There is still a risk that the priceline value proposition,
especially with regard to the airline ticket business, will |
