Briefing.com sez:
Stock Brief
Updated: 20-Mar-00
Name Your Risk For priceline.com
[BRIEFING.COM - Robert V. Green] In a article published this weekend, Barron's magazine described the risk faced by priceline.com of an industry consortium formed to compete with them. But the magazine failed to list some of the other risks also faced by priceline.com, and investors.
The Consortium Risk
The Barron's article addresses a simple, but potentially huge threat to the priceline.com (PCLN) model: that the airlines and hotels join together to offer their own low priced ticket service.
The article discusses plans by United, Delta, Northwest and Continental to do just that. You may not be able to "bid" on an airline ticket there, but if the airlines put up fixed prices, on known routes, travelers may well be pulled to that site instead of priceline.com.
In fact, a dutch auction style of selling empty seats, where the price falls every day, or every hour, could be far more appealing to travellers than the "pig-in-a-poke" style of buying that priceline.com offers.
The article also alludes to a consortium of hotels who are planning the same type of cooperative web site.
These are pretty serious potential challenges to priceline.com's market. But the advent of competition isn't the only risk facing priceline.com investors.
The Revenue Recognition Risk
The Barron's article misses the biggest risk to PCLN stock.
First detailed in a Briefing.com Stock Brief of July 19, 1999, the problem is simple. Priceline.com reports the entire price of an airline ticket as revenue, with the amount of the ticket as cost of goods sold. This leaves the commission as gross margin.
Travel agencies count only the commission as revenue. What does priceline.com look like when only the commissions are counted? The following table shows that, instead of being the gorilla of the group, priceline.com isn't dominant at all.
Revenues, as reported (MM) Revenues, commissions (MM)
priceline.com 482 57.8
Expedia 58 58
Travelocity 91 91
This is an important issue to consider when comparing priceline.com to other ticketing agencies. Depending on which revenue figure you think is correct, priceline.com is either slightly expensive, or an order of magnitude out of whack!
Price/Sales, reported revenues Price/Sales, on commissions
priceline.com 27 223
Expedia 18 18
Travelocity 22 22
The market doesn't seem to have factored this issue into priceline.com stock at all. Nevertheless, we think counting only the commission as revenue is the accurate way to view priceline.com, especially when comparing it to its peers.
The Operating Margin Risk
If you accept the fact that priceline.com's current revenue stream should be based on commissions, what does the operating margin trend look like?
Here is a table, using commissions as revenue, and adjusting the operating margin by excluding warrant costs and supplier start up costs from expenses.
Q1 99 Q2 99 Q3 99 Q4 99
Revenue (MM) 5.4 10.5 18.2 23.7
Operating Inc. (MM) (17.6) (16.2) (16.2) (13.4)
Margin % (326) (154) (89) (56)
The operating margin is certainly headed in the right direction, in terms of percent. But the absolute numbers tell a puzzling story.
Revenue doubled in Q4, over Q2, and the operating income only improved by $3 million. And what happened in Q3? The nearly eight million in extra revenue didn't add a dime to the operating income.
In fact, since Q1, $18 million was added in revenue, but the operating income only declined by $4 million.
This isn't the way that scalable models are supposed to work. As revenue increases, each incremental dollar is supposed to bring a higher margin with it. That isn't happening.
Perhaps all the extra expenses are going to William Shatner. (They certainly can't be going to Mr. Shatner's singing instructor.)
The Patent Lawsuit Risk
Much of priceline.com's current valuation is based on the fact that they have a "unique pricing model." Priceline.com even patented the process.
But priceline.com does not own the "idea" of bidding for an item. The end result of a process cannot be patented. Only the process that achieves the end result is patentable.
Microsoft is clever enough to devise a methodology for bidding which differs significantly enough from priceline.com's methodology. After all, priceline.com's methodology is publicly available in the patent.
What will happen to priceline.com's valuation if Microsoft wins this lawsuit? What will happen to PCLN if the market begins to sense that the "name your own price" model really isn't patentable?
The Product Extendibility Risk
The priceline.com model clearly works for airline tickets. People are willing to make low bids, without regard to airline brand, for certain types of travel.
But airline tickets and hotel rooms are "perishables." The value of unused airplane seats disappears the moment the plane takes off. No one wants to rent room for "last week."
Does the priceline model work for nonperishables? Briefing.com first examined this question in a Stock Brief of September 20, 1999.
Although priceline.com is expanding as fast as it can into other areas, there really isn't proof yet that it does work. It is still unclear that people will prefer to make a bid on an unknown car when Carsdirect.com might list a car for as close to cost as you can get. And give you a chance to test drive before making a $250 commitment.
But PCLN is priced as if the priceline model will work on everything.
How else can you explain that priceline.com is worth more than United ($2.5b), Delta ($5.5b), USAir ($1.3b), Northwest, ($1.4b), and Continental ($2b), combined. Even the largest airline, American, is only a little more than half ($7.5b) of priceline.com's value.
How can an agency seller of the lowest priced tickets on an airline be worth more than the bulk of the entire airline industry? The market clearly thinks priceline.com is going to succeed in many other arenas. But it has already priced it to win.
Briefing.com Analysis
It is common to find a stock whose underlying business is good, but whose stock valuation makes it a risky investment. Red Hat (RHAT) is an example.
It is also common to find a stock whose stock valuation is exceedingly low, but whose basic business has serious risks associated with it. Philip Morris (MO) is an example.
But it is rare to find a stock with both huge valuation risks and huge fundamental business risks. Priceline.com has both.
The product extension, industry consortium risk, and patent lawsuit are all business risks. The revenue recognition, operating margin trend, and patent lawsuit risks, are stock valuation risks. The patent lawsuit appears in both places because losing the lawsuit opens up priceline.com to more competition, and destroys the market valuation on priceline.com's supposed lock.
All investment decisions are risk/reward decisions. Anyone considering PCLN as part of their portfolio should take a moment to consider what they are willing to bid for the multiple risks behind priceline.com.
Priceline.com won't tell you, prior to bidding, what airline or route you are bidding on. That's part of their model. But, don't make the mistake of bidding on priceline.com stock without knowing what risk you are taking on.
Comments may be emailed to the author, Robert V. Green, at rvgreen@briefing.com |
