SmartMoney. Can Priceline.com Ever Make Money?
March 9, 1999
Can Priceline.com Ever Make Money?
By Gerri Willis
IN THE strange world of Internet
IPOs, the more losses a
fledgling company reports in its
prospectus, the bigger the pop
on the first day of trading. The
reason for this, one can only
assume, is that investors view
the badge of negative earnings
as proof positive that the new
company is positioning itself to
take full advantage of the
commercial potential of the Internet.
Under that weird calculus, the imminent public offering of priceline.com
should be, in the words of the company's chief pitchman, William Shatner,
"big, very big." The Internet auction site, which urges consumers to bid on
unsold airline tickets, new cars, mortgages and other goods and services,
lost a hefty $90.2 million on sales of $35.2 million for 1998. It's not unusual
for fledgling companies to be in the red, but unlike some other unprofitable
Internet ventures, there are serious questions about whether priceline can
ever make money.
Internet auctioning already is profitable for some companies, especially
eBay (EBAY). But priceline's system is different -- and that's the problem.
Unlike eBay, priceline has had to pay for access to the airline tickets it
auctions on its site. The company recorded $38.9 million in noncash
charges in the form of warrants to insure a steady supply of airline tickets
from Delta Air Lines (DAL) and other carriers. What priceline is getting for
all that is questionable.
Priceline takes a bid from a consumer and matches it against the inventory
offered by any of the 18 airlines with which it does business. (Airline tickets
account for the bulk of priceline's total volume.) Often, there is no match.
Last year, only about 7% of the guaranteed offers from consumers actually
resulted in a sale -- usually because consumers bid way too low. When
there is a match, priceline gets to keep the difference between the bid and
the offer as profit. Fair enough, but priceline is accepting bids on many
tickets where the company is actually losing money. "Priceline.com has
chosen to sell a substantial number of tickets below its cost in order to
increase airline and adaptive marketing revenues, build a record of
successful transactions and enhance the priceline.com brand," according to
the company's prospectus. In fact, it's hard to tell just how many tickets
priceline is selling below cost, or at how much of a loss. What happens to
that 7% sell-through when the company tries to actually make money on
the tickets it sells?
The company's prospectus doesn't reveal priceline's customer traffic during
the nine months the service operated last year, but sales doubled from the
third quarter to the fourth to $18.99 million. While sales may look like they
are rocketing, understand that priceline's revenue represents gross ticket
sales. Like any travel agency, revenue is counted as the entire ticket price
even though most of the money goes directly back to the airline.
An increasing stream of revenue
is coming from the marketing
fees priceline earns when
consumers apply for credit
cards on the Web site. Such
fees accounted for about $4
million of last year's $35.2
million in sales. The problem
with this strategy is that there is
no guarantee that users will be
willing to sign up for credit cards or other products on an ongoing basis.
Even if revenue from such marketing programs increases dramatically,
priceline's main business is still auctioning airline tickets and, to a lesser
extent, other goods and services. And that's where priceline's business
strategy runs into serious trouble.
Let's start with the competition. Travelocity.com, which is a unit of the
Sabre Group (TSG) and American Airlines by extension, reported gross
sales from its online business for January alone of $40.5 million, 4% better
than priceline was able to do in the nine months it was operational last year.
Of course, much of this difference is simply due to longevity. Travelocity has
been around since March 1996 -- an eternity in Internet time.
But priceline is also feeling the heat from less well-known competitors. At
about the same time that priceline is coming public, another travel site,
Cheap Tickets Online, is planning to offer shares as well. This company,
online since October 1997, has deals similar to priceline's to offer seats that
otherwise would go unfilled on major airlines. What's more, Cheap Tickets
actually had net income last year of $1.1 million on sales of $171 million.
But you're less likely to have heard of Cheap Tickets, because the married
couple that founded the business 13 years ago in Hawaii spent just $3.8
million on advertising last year, less than a sixth of priceline's total
marketing budget. There are loads of other competitors, too, including the
sites of airlines themselves, which do brisk business.
Another troubling aspect for priceline is the amount of leverage the company
has given to Delta Air Lines, its most important supplier of tickets.
Basically, Delta can nix any other airline partners that priceline might want
to bring on. It can also prevent other airlines from offering tickets through
priceline on specified routes. Plus, Delta can stop supplying tickets to
priceline anytime it wants. Obviously, priceline executives believe that Delta
will find it's making so much money from priceline that it will want to extend
the relationship. And priceline is providing incentives to Delta to do just that.
The airline holds a warrant to buy 10% of the company's shares at an
exercise price of $1.16 a share, once certain performance thresholds of
ticket sales occur.
Perhaps the most serious obstacle priceline faces is consumer acceptance
of the site itself. Tom Parsons, editor of BestFares.com, says that when he
solicited his readers for a reaction to priceline's service last summer, the
overwhelming response was negative. "Ninety percent of the people weren't
happy with what they got," he says. What were their beefs? Travelers didn't
like the fact that they couldn't choose the airline they wanted, the time of
departure or whether they had to make connections to their destination.
Priceline executives, who couldn't comment for this story because of the
pending IPO, haven't made any secret about the shortcomings of the airline
tickets the site offers. The tickets are nonrefundable, can't be changed and
cannot be used in frequent-flyer programs. Even so, you don't have to go far
on the Web to find complaints about these limitations.
So what will priceline's financials look like in 1999? The best news is that
payments to airlines should fall dramatically to $500,000 from $38.9 million,
according to the prospectus. Most of the 1998 charge was to establish the
Delta relationship, but don't expect a commensurate decline in ad spending.
In the prospectus, priceline executives make it clear that they plan to
continue spending big dollars to build the company's brand name. As a
result, priceline doesn't expect to be profitable for some time. "We have not
achieved profitability and expect to continue to incur losses for the
foreseeable future," states the prospectus.
Despite all that, investors seem to be lining up to get in on the IPO. "We're
getting more inquiries about this than anything we've seen except maybe
Yahoo! (YHOO)," says Kathy Smith of Renaissance Capital, a Greenwich,
Conn., firm that tracks IPOs. And some analysts can't say enough good
things about the company. "Seventy-five to 85% of the customers who buy
a ticket will use priceline again in 90 days," says Howard Anderson,
president of the Yankee Group. "Priceline may change buying patterns in
both the consumer and the business markets. They are an airline without
wings."
What's more, priceline is backed by some of the best-known names in the
technology business. Early investors include Vulcan Ventures, an
investment firm owned by Microsoft (MSFT) co-founder Paul Allen; Jim
Manzi, former chief executive of Lotus Development; Liberty PL, a
subsidiary of Liberty Media Group (LBTYA), which is a unit of John
Malone's Tele-Communications (TCOMA); General Atlantic Partners, a
Greenwich, Conn., investment firm; and Quantum Industrial Partners, a fund
managed by Soros Fund Management (yes, that Soros). Together, they've
infused the company with $100 million.
That's not the end of the famous names either. The lead manager of
priceline's IPO is the well-regarded Morgan Stanley Dean Witter, and its
CEO, Richard Braddock, is the former president and COO of Citicorp, now
Citigroup (C).
With that kind of pedigree and priceline's high profile, investors aren't likely
to worry too much about competition and consumer acceptance. In other
words, Shatner is likely to be right. Priceline will be big, very big indeed.
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