PCLN Buy recommendation - Wit Capital
March 30, 1999
Priceline.com
NASDAQ: PCLN
Rating: BUY
Jonathan H. Cohen, Director of Research
Ryan B. Alexander, Vice President
The First 'Next Generation' Internet Commerce Company
Price (as of 3/30/99) $16.00
Shares Out. (in mil.) 142.3
Market Capitalization $2.28 billion
Float (% of shares out.) 7.0%
Industry E-Commerce
Projected LT Operating Margin 8.0%-10.0%
Fiscal Year Dec. 31 1998A 1999E 2000E 2001E Q1/99E
Revenue (in mil.) $31.2 $197.0 $330.0 $560.0 $42.5
Revenue Multiple 73.0 11.6 6.9 4.1 NM
EPS $(1.41) $(0.46) $(0.31) $(0.04) $(0.14)
P/E NM NM NM NM NM
** Last night, Priceline.com completed its IPO and priced 10.0 million
common shares at $16.00 per share. *
** We believe that Priceline is positioned to fundamentally change the
existing model for online commerce.
** We are enthusiastic about Priceline because its business model is not
only based upon an entirely valid intellectual construct (rather than on an
existing market opportunity), but also because it is built upon a portfolio
of proprietary intellectual property.
** Unlike most e-commerce businesses that have sought to build franchises
within one or two vertical markets, Priceline has created a cross-segment,
or horizontal, commerce system whereby buyers and sellers can benefit across
a broad range of market segments.
** Our preliminary (and admittedly broad) valuation construct of $5.0 -
$7.0 billion translates into a per share price range of $35 - $50 (although
we believe that the shares could trade above that range after the pricing of
the transaction).
** Internet stocks are speculative investments. Only those investors whose
objectives include speculation should consider purchasing the common shares
of Priceline. For those investors, we recommend purchase of Priceline's
shares even at a substantial premium to the expected offering price. Given
the price volatility that will most likely be associated with the common
shares of Priceline, we further recommend that investors use limit orders
rather than market orders.
DISCLAIMER: *Wit Capital did not participate in the Priceline.com common
stock offering.
Please refer to the notes at the end of this report for additional
information. (c) Copyright 1999 by Wit Capital Corp.
Company Overview
Formed in July 1997, Priceline.com is an Internet commerce service company
that we believe is positioned to fundamentally change the existing model for
online commerce. The company has constructed a unique and highly efficient
commerce system that enables consumers to essentially 'name their price' for
a variety of products and services. Priceline's patented demand collection
system simultaneously benefits buyers, who are willing to exchange some
degree of specificity with regard to brands or vendors in return for prices
that are lower than those that could have been obtained from traditional
retail distribution channels, and sellers, who are able to generate
incremental revenue without disrupting their existing distribution channels
or retail pricing. We believe that Priceline's functionality is enormously
valuable and wholly unique, and, given its scalability, unlike any other
Internet commerce company.
Leisure Airline Tickets
Priceline commenced its service on April 6, 1998, with the sale of leisure
airline tickets and now has five domestic and 13 international airlines,
including Delta, Northwest, TWA, and America West, participating in its
ticket service. Airline ticket sales currently comprise the majority of
Priceline's total revenue, with the company's gross margin reflecting the
spread between the consumer's named price and the fare charged by the
airline.
During the period from launch through December 31, 1998, Priceline collected
guaranteed offers for approximately 1.9 million airline tickets,
representing approximately $400 million in total consumer demand. That
demand resulted in sales of approximately 134,000 airline tickets,
representing approximately $30.4 million in revenue. During the first two
months of 1999, the company has collected guaranteed offers for
approximately 830,300 airline tickets, representing approximately $170
million in total consumer demand. That demand resulted in sales of
approximately 102,700 airline tickets, representing approximately $21.1
million in revenue. Because Priceline does not establish minimum offer
thresholds and consumers are not charged to make offers, the company
receives a significant number of unreasonable offers. Consequently, the
company analyzes 'reasonable' ticket requests that it is able to fill.
(Reasonable ticket requests are those requests that are no more than 30%
lower than the lowest generally available advanced-purchase fare for an
identical route.) Using that standard, the overall percentage of ticket
requests considered reasonable for the two-month period ended February 28,
1999, was approximately 53%.
The travel business is inherently competitive, both online and through
traditional sellers of travel products and services. As a result and in an
attempt to establish the company's brand and to develop strong customer
relations, Priceline has chosen to sell a number of airline tickets below
cost. We believe that over the near term that strategy is appropriate, since
it will not only increase the company's airline ticket and adaptive
marketing revenues, but it is more likely to leverage a consumer's positive
experience purchasing airline tickets through Priceline into other markets
in which the company currently offers services. Moreover, we view that
practice as an enormously cost-effective customer acquisition mechanism.
Priceline currently generates approximately 15% of its airline ticket orders
through its toll-free number (1-800-Priceline). Finally, in order to
encourage reasonable initial offers, customers are not permitted to revise
their offers for an identical itinerary within seven days of an unsuccessful
offer.
New Car Sales
Priceline introduced a new car sales service on a test basis in the New York
metropolitan area in July 1998 and currently accepts offers for every major
brand of automobiles. During the first half of 1999, Priceline intends to
introduce its new car sales service in a prototypical market, with a
nationwide rollout to follow.
When purchasing a car from Priceline, consumers indicate the price for the
car with specified model options and agree to purchase such a car from any
factory-authorized dealer within a specified geographic radius. To assist
consumers in submitting reasonable offers, Priceline provides the
manufacturers suggested retail price and the dealer invoice price for the
vehicles and requested options. When a transaction is completed, Priceline
receives $25 from the customer and an additional fee from the auto dealer.
Competition within the new automobile market segment includes newly
developing auto superstores such as Auto Nation, Autoweb, Auto-by-Tel, and
Microsoft's CarPoint.
Hotel Accommodations
In October 1998, Priceline launched its second travel service, hotel
accommodations, which represented a natural extension to offering leisure
airline travel tickets. Again, consumers have been willing to relinquish a
degree of flexibility in exchange for cheaper rates, while Priceline earns
the spread between the consumer's offer price and the price charged to the
company by the hotel. Participants in the Priceline hotel reservation
service include Marriott, Renaissance, Sheraton, Westin, and several other
nationally recognized hotel chains, as well as several real estate
investment trusts, including Meristar, Patriot, and Starwood. Priceline's
hotel reservation service is currently available in more than 200 cities,
and the company intends to expand its hotel reservation service during 1999
to include substantially all major cities and metropolitan areas in the
United States and a number of international destinations.
Financial Services
Priceline's initial financial service offerings, home mortgages, which it
introduced in January 1999, enables consumers to name their price (expressed
in terms of interest rates) for mortgages of a specified term, including
purchase money mortgages, refinancings, and home equity loans. Under its
joint marketing relationship with LendingTree, an Internet-based mortgage
service provider, Priceline maintains the mortgage service aspect on its Web
site, while LendingTree, with access to approximately 20 mortgage-lending
institutions, serves as the mortgage broker. Priceline's mortgage service
capitalizes on consumers' typical indifference to which mortgage issuer
provides their mortgage. That indifference enables Priceline to provide
consumers with the lowest cost mortgage in the most efficient manner. Upon
the closing of a mortgage, LendingTree receives a fee from the lending
institution, and Priceline receives a fee from LendingTree. Priceline's
online competitors within the financial services market include Quicken
Mortgage, E-Loan, and Home Shark.
Adaptive Marketing Programs
Priceline has developed adaptive marketing programs to help bridge the gap
between consumer offers and seller prices, to provide users of the company's
service with other desired products, and to generate additional revenue.
Those programs, which we believe assist Priceline in building customer
loyalty, presently include two distinct initiatives, adaptive cross selling
and adaptive promotions. Adaptive cross selling utilizes cross selling of
multiple products to increase the number of successful transactions. For
example, a customer whose offer for an airline ticket was slightly below
acceptable levels could be offered a second related product such as a hotel
room reservation or a rental car day at a combined price that would provide
an acceptable margin for the two sellers and for Priceline. Adaptive
promotions, Priceline's second adaptive program, enable customers to
increase the amount of their offers, and thus the likelihood of success, at
no additional cost by participating in sponsor promotions during the process
of making an offer. For example, a customer making an offer to purchase an
airline ticket can immediately increase their offer by $50 by applying
online for a credit card. Specifically, if a customer makes an offer to buy
a round trip ticket for $100, and in the process of making that bid, that
customer applies for a credit card, the offer would be submitted for $150,
but the customer would only have to pay $100 for the ticket. In addition to
the credit card arrangement, Priceline has similar adaptive marketing
arrangements with E*TRADE Group and NewSub Services, a magazine subscription
agent. To date, a significant portion of Priceline's gross profit has been
generated from such arrangements.
Industry Overview
We expect that Internet-based growth will continue unabated over the
foreseeable future. For those Internet companies properly positioned, that
growth translates into an essentially unlimited ability to grow revenue over
the next 3-5 years. We believe that an unprecedented percentage of the
domestic population will have access to the Internet over the next several
years (we believe up to 95% of the total U.S. population may have Internet
access by year-end 2004), and we expect that the dramatic recent increases
in the overall volumes of online commerce will continue during that
timeframe.
While the Internet has become a significant medium for conducting business,
commerce presently conducted on the Internet is largely based upon
traditional retail pricing methods. Under that model, which is fundamentally
seller-driven, certain significant disadvantages exist for both sellers and
consumers. For example, sellers who discount prices to eliminate excess
inventory risk disrupting their existing distribution channels and damaging
their retail pricing structures. The existing construct also prevents
sellers from capturing incremental revenue from 'free riders,' or those
consumers that would have paid the original, undiscounted price but
nevertheless obtained the benefit of a discounted price. Additionally,
consumers are often forced to pay a higher price when the seller is setting
a fixed retail price for a product with added features or under a specific
brand, which the consumer would otherwise have been willing to forgo for a
lower price. Auctions force consumers to compete against each other for the
benefit of the seller, which always results in the product being sold on the
basis of the highest bid.
Investment Overview
A Service Scalable Across Multiple Markets
Unlike most e-commerce businesses that have sought to build franchises
within one or two vertical markets (such as books, music, travel, etc.),
Priceline has created a cross-segment, or horizontal, commerce system
whereby buyers and sellers can benefit across a broad range of market
segments. The implication of that model is that Priceline has the ability to
build brand equity across multiple product categories (airline tickets,
hotel rooms, new cars, home mortgages, etc.). In doing so, we believe that
the company will be able to generate substantial economies of scale
(relative to companies that are primarily identified with a single product).
We expect that Priceline's ability to leverage the costs associated with
building its brand across a range of product categories will represent a
meaningful competitive advantage. In the future, Priceline anticipates
expanding its current offerings into additional market segments, including
rental cars, cruises, time-shares, vacation packages, insurance and other
financial services, and a limited number of retail products.
A Truly Proprietary Platform
We are enthusiastic about Priceline because its business model is not only
based upon an entirely valid intellectual construct (rather than on an
existing market opportunity), but also because it is built upon a portfolio
of proprietary intellectual property. Priceline's system is an organic
product of the growth of Internet connectivity: the company's business model
could not exist without the structure of the Internet. Unlike those
operating models that have been transplanted from the physical world to the
virtual world, Priceline's business model suggests that the company's
competitive advantage should scale with the growth of the Internet.
Priceline's intellectual property portfolio, which currently includes a
United States patent directed to a unique Internet-based buyer-driven
commerce method and system (5,794,207), a United States patent directed to a
method and system for pricing and selling airline ticket options
(5,797,127), an allowed patent application directed to methods and systems
for generating airline-specified time tickets, 18 pending United States
patent applications, and one international patent application, will provide
the fundamental building blocks for the company's continued horizontal
expansion. In addition, Priceline has an ongoing program for identifying and
protecting new inventions and modifications to its existing inventions.
As a cautionary note, Priceline's patents have recently been challenged. We
would refer potential investors to our discussion below regarding the
company's risk factors.
All Participants Concurrently Benefit
We believe that Priceline has created a new model which mediates the
interests of buyers, who are willing to accept trade-offs in order to save
money, and sellers, who are able to monetize units of demand that would have
otherwise gone unfilled while protecting their existing distribution
channels and retail pricing structures. We believe that consumers will
benefit by being able to obtain prices that are lower than those that can be
obtained through traditional retail channels of distribution, by efficiently
evaluating a complex array of alternative choices simultaneously, and by
eliminating the potential haggling typically associated with certain types
of purchases (i.e., purchasing a car). In addition, consumers are not
charged for submitting an offer, and Priceline's service is available 24
hours a day, seven days a week.
Because commercial sellers of commodity goods and services set pricing
according to a wide range of factors (including maximizing profit,
preserving an existing distribution system, maintaining brand equity, etc.),
there will always exist some significant level of demand which must be
sacrificed to fulfill those frequently competing objectives. We believe that
the Priceline system is extremely attractive to sellers, who are able to not
only generate incremental revenue through a low cost distribution channel
without disturbing existing retail channels, but, in certain instances, are
also able to capture market share from non-participating competitors. The
elegance of the Priceline solution is that it permits sellers to view latent
demand characteristics at each price point below their retail prices.
Priceline Management
Richard S. Braddock has served as chairman of the board of directors and
chief executive officer of Priceline since August 1998. Throughout Mr.
Braddock's career, he has held a variety of positions, including the
non-executive chairman of True North Communications and Ion Laser
Technology; a special advisor to General Atlantic Partners; a principal of
Clayton, Dubilier & Rice; the chief executive officer of Medco Containment
Services; and president and chief operating officer of Citicorp. Mr.
Braddock also serves as a director of NewSub Services; Amtec, a
semiconductor equipment manufacturer; Eastman Kodak Company; E*TRADE Group;
and Cadbury Schweppes.
Jay S. Walker is Priceline's founder and has served as vice chairman of the
board of directors of the company since August 1998. From inception through
August 1998, he served as the company's chairman of the board of directors
and chief executive officer. Mr. Walker currently serves as chairman of the
board of directors of Walker Digital Corp., which he founded in September
1994, and as non-executive chairman of NewSub Services, which he co-founded
in 1992.
Jesse M. Fink has been chief operating officer of Priceline since its
inception. Mr. Fink also serves as the chief operating officer of Walker
Digital Corp. and has served in various capacities with C.U.C.
International, including divisional senior vice president of new business
development.
Paul E. Francis has been the chief financial officer of Priceline since its
inception. Mr. Francis was previously the chief financial officer of Walker
Digital, the chief financial officer and a member of the board of directors
of Ann Taylor Stores, and a managing director at Merrill Lynch & Co.
Ronald V. Rose has been the chief information officer of Priceline since
March 1999. Prior to joining Priceline, Mr. Rose served in various
capacities with Standard & Poor's, including chief technology officer of
retail markets.
We have spent a great deal of time with Priceline's senior management over
the past six months. During our conversations, we have been enormously and
consistently impressed with the vision and focus of the people who have
built the company. We believe that Jay Walker's vision for Priceline extends
considerably beyond the model for online commerce that most other companies
have pursued. Mr. Walker (together with Rick Braddock and the rest of the
company's senior management) has created an enterprise that has the ability
to leverage the structure of the Internet on a massive scale. We believe
that Priceline's operating model represents the product of many years of
thought and activity regarding the process by which buyers and sellers come
together in the most efficient way possible. To the extent that we regard
the Priceline solution as both highly innovative and effective, we believe
that investors should benefit as that solution becomes more broadly
deployed.
Investment Considerations/Risk Factors
Ability of Priceline to Develop Additional Markets
A significant portion of the total revenue Priceline has generated to date
has been from the travel industry, an industry characterized by "expiring"
inventories. (If not used by a specific date, an airline ticket or hotel
room has no value.) That expiring nature creates incentives for airlines and
hotels to sell seats or room reservations at reduced rates. Since Priceline
has limited experience selling 'non-expiring' inventory, such as financial
services or new cars, there may be an inherent risk in that type of industry
expansion.
Current Legal Proceedings
On January 6, 1999, Priceline received notice that a third party patent
applicant and patent attorney, Thomas Woolston, purportedly had filed in
December 1998 with the United States Patent and Trademark Office a request
to declare an interference between a patent application filed by Woolston
describing an electronic market for used and collectible goods and
Priceline's core buyer-driven commerce patent. In addition, on February 22,
1999, Marketel filed an amended complaint (to their initial complaint filed
on January 19, 1999) alleging that Priceline conspired to misappropriate
Marketel's business model, which it describes as a buyer-driven electronic
marketplace for travel services, and which an executive of Marketel
allegedly provided to Priceline management in confidence approximately 10
years ago. While Priceline believes both challenges are without merit and
intends to defend them vigorously, not only could a long and drawn-out
dispute divert management's attention on building the Priceline franchise,
but any negative outcome regarding those disputes could substantially impact
the company.
Valuation
While many existing Internet commerce companies are positioned to benefit
from the continued growth of the online medium, we believe that those
capable of distinguishing themselves in terms of functionality will provide
investors with truly exceptional long-term performance. Our premise here is
that the value of both proprietary intellectual property and proprietary
functionality increases with the increasing transparency of their
distribution mechanisms. We strongly believe that the usefulness and value
of Priceline's commerce system will increase dramatically as the Internet
becomes more pervasive and much broader-band. We note that Priceline's model
is proprietary and unique, and that it seems to represent a significant
advancement to the current state-of-the art in terms of matching buyers with
sellers.
Post IPO, Priceline should have approximately 142.3 million common shares
outstanding. Our preliminary (and admittedly broad) valuation construct of
$5.0 - $7.0 billion translates into a per share price range of $35 - $50
(although we believe that the shares could trade above that range after the
pricing of the transaction). Our valuation methodology is based on the
application of a price to forward revenue multiple applied to our calendar
year 2000 revenue expectations (of $325 million) regressed against projected
long term operating margins. (We note that that regression reflects the
valuations of comparable companies within the Internet sector, and, as such,
could shift [positively or negatively] in response to changes in those
valuations.) Given the agency-oriented structure of Priceline's commerce
platform, and in view of our belief that the company will be able to
generate substantial economic returns on its fixed assets (together with an
exceptionally low prospective variable cost structure), we expect that
Priceline should be able to generate operating margins in excess of 8.0% -
10.0% over time. On that basis, we recommend purchase of the company's
shares even at a substantial premium to the expected offering price.
Internet stocks are speculative investments. Only those investors whose
objectives include speculation should consider purchasing the common shares
of Priceline. Given the price volatility that will most likely be associated
with the common shares of Priceline, we recommend that investors use limit
orders rather than market orders even though limit orders carry higher
commission rates than market orders.
The information and opinions in this report were prepared by the authors who
are employees of Wit Capital Corporation and is current as of the date of
the report. This report was prepared from sources that are believed to be
reliable, but we cannot assure you that these sources were complete, timely,
or accurate.
The investments discussed in this report may not be suitable for all
investors. Investors should make their own investment decisions based upon
their own financial objectives and financial resources. Investors should be
aware that the market price of the securities discussed in this report may
be volatile.
Wit Capital Corporation did not participate in the current public offering
of Priceline.com.
Wit Capital Corporation's affiliates or employees may have a long or short
position or hold options on securities or other related investments of the
company discussed in this report.
This report is for informational purposes and is not intended as a
recommendation or an offer or solicitation of an offer to any person with
respect to the purchase or sale of the security discussed in this report.
This report is intended for United States citizens.
Additional information is available upon request.
This report may not be reproduced, stored in a retrieval system, or
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(c) Copyright 1999 by Wit Capital Corporation. |
