Thursday, June 7, 2007

Travelzoo: Smart Investments to Further Growth

Travelzoo is an internet company that provides travel companies with a place to advertise their deals and consumers with a great tool to search for travel deals. Their product provides consumers a free search to look for travel offers. Some of their big advertisers are companies such as airlines, hotels, cruise lines, vacation packagers and other travel companies. Their products include their Travelzoo website, the Travelzoo Top 20 e-mail newsletter, SuperSearch and their Newsflash e-mail product. Their operations are based in North America and Europe. Their founder, Ralph Bartel, is still with the company and owns 50.2% of the outstanding shares.

The recent stock downfall was due to a 1st quarter that did not reach analyst expectations. Analysts expected $0.32 per share but they earned only $0.25 per share. It was still an increase compared to the same time period last year, but that was only because of the smaller number of shares outstanding, Net Income went down. The increased expenses can mostly be attributed to a rise in sales and marketing expenses and an increase in the income tax rate. Its Canadian and European operations, which were just recently launched, are still experiencing losses.

They are also currently experiencing downward price pressure on the stock due to their program to make cash payments to people who failed to convert their shares of Travelzoo.com Corporation to Travelzoo Inc., this is due to their mergers of different Travelzoo companies. There is no estimate of how much this program will cost the company.

Industry

This is a booming industry, travel companies are involved in a lot of advertising and the internet offers them significant medium advantages over newspapers. First, the company can update their ads real-time, unlike in newspapers where you have to wait until their customer service opens and a delay to update the ad. Second, these ads are more effective, targeting people who are looking for travel deals. Third, these are cheaper than placing ads in the newspaper and the travel deals are being sold direct, not through a 3rd party such as a travel agent. The internet offers travel companies much more flexibility than a newspaper does. Travelzoo will continue to benefit in the shift to internet advertising.

Travelzoo faces competition from big competitors such as Microsoft, Google, Yahoo! and other internet websites that offer a travel search similar to Travelzoo’s. This industry is part of the internet mega trend.

A downturn in the economy will hurt their performance due to the sensitivity of the travel market to the economy. Also, terrorist attacks might severely hurt Travelzoo’s operation due to fear like after the horrific events of 9/11.

Company

95% of their revenue comes from the United States. They recently had a slip in revenue per employee due to new growth expansion. They currently have 94 employees. Technology is very important for Travelzoo, they will have to continue to innovate to compete with different internet travel websites. Brand awareness is essential for success in the internet travel industry. The amount of new subscribers to their two email services have been steadily going down. Their total subscribers has been increasing but the number of new subscribers has been increasing at a decreasing rate. Their goal is to continue expanding into other geographical locations and expand their reach. Their executives are relatively low paid compared to the outrageous salaries executives are earning now.

Valuation

TZOO is currently trading at a trailing P/E ratio of 25.12 and a forward p/e ratio for fiscal year 2008 of 18.75. Their full year 2007 and 2008 earnings have both been revised down recently. Their balance sheet is strong, they have almost $40 million of cash and cash equivalents and no debt. Insiders own almost 57% of the shares outstanding. Their share count has been shrinking with recent buybacks. They bought back 1,000,000 shares in 2006 and just authorized an additional 1 million share buy back. Their free cash flow is strong. Revenues have been growing at an exceptional level, even in a bad quarter like last quarter, revenues grew 17% year-over-year. TZOO was in the top 25 Magic Formula stocks with a market cap of over $100m as of 6/6/2007.

Technicals

Currently TZOO is trading at below its three major moving averages. The 50DMA just crossed below the 200DMA, not a good sign for things to come. The big recent drop on higher volume does not bode well for short-term momentum. It is currently right around very solid support of $25 a share. The $25 level has acted as support for over a year. TZOO has traded between $25 and $40 a share for the past year. RSI is giving an oversold signal with a slight bullish divergence. MACD is showing slight bullish momentum.



Conclusion

Travelzoo will continue to benefit from industry trends such as the continuous shift of advertising from newspapers to the internet and the wider use of the internet. This slipup in the first quarter was not major, they are continuing to spend on growth and short-term earnings will suffer because of that. Growth always involves an initial investment which will create downwards pressure on earnings. I would be more concerned if Travelzoo was not making new investments. If these sales & marketing investments were capitalized, similar to new equipment investments of a manufacturer, this would alleviate the pressure on earnings. Revenue is still growing at a brisk pace.

Disclosure: I don’t have a position in TZOO.

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