In a surprising move, Priceline (NASDAQ:PCLN), a leading online travel agency (OTA) announced its acquisition of Kayak, a leading travel search company, in November 2012. The two companies signed a definitive agreement for a stock and cash agreement of $1.8 billion. Priceline will pay $500 million in cash and the remaining $1.3 billion in equity for the deal, which is expected to close by mid 2013. The $40 per share price tag offered by Priceline marks a 54% premium over Kayak's initial listing price of $26.
Priceline has been able to successfully leverage its past acquisitions, which have substantially contributed to its growth over the years - Booking.com (2005), Agoda.com (2007) and TravelJigsaw (2010). The Kayak deal seems to be in line with the company's strategy of growing through acquisitions to build a robust and well-rounded travel portfolio. The Kayak acquisition is the biggest deal for Priceline so far as its previous acquisitions have been approximately $100 million each.
Though we do not believe that the acquisition will provide Priceline a substantial edge over other OTA's in the global market, we feel that getting Kayak on board will help it close the gap with Expedia in the U.S. market.
Here we list the potential benefits and inherent risks for Priceline from the Kayak acquisition.
Kayak Can Add Value to Priceline's Travel Search & Advertising Platform
Priceline is the second-largest online travel company in the world in terms of gross bookings. So far, Priceline has been focusing only on the transaction channel of online travel, i.e. selling travel products such as airline tickets, hotel rooms, cruise packages and car rental services. However, with the acquisition of Kayak, it marks its entry in the meta-search space. A meta-search engine is a search tool which collates results from multiple search engines giving a broader scope to user searches. Meta-search remains an integral part of the online travel booking supply chain.
We feel that the acquisition could serve as a way for Priceline to expand its paid search or advertising offerings, an area where it does not have much exposure currently. While revenues from advertising contribute very little to Priceline's overall earnings, for Kayak, with a contribution of 58% in 2011, advertising is an important revenue stream. We believe that the expansion of its advertising platform can broaden and diversify Priceline's revenue base.
Potential Risk - There is a possibility that the acquisition will discourage Priceline's competitors from advertising on Kayak. However, with a 53% share of the U.S. meta-search market, Kayak remains a great resource for customers and delivers attractive return on investment for its advertisers [Who is so far feeling the heat from Google Flight Search? No major surprises here, tnooz, February 17, 2012]. Thus, we do not foresee any significant decline in its advertising revenue post the acquisition.
Priceline Can Reduce Its Dependence on Google
According to Travel Trends, Priceline is one of Google's biggest customers, having spent close to $375 million in online advertisement in Q3 2012 alone
[What does the Priceline-Kayak deal (and Google lurking in the background) mean for hotel marketing?, tnooz, December 5, 2012]. However, with Kayak on board, Priceline might reduce its dependence on Google to get traffic for its website. With the launch of Google Flight Search and Google Hotel Finder, many online travel companies have accused the online search engine of placing its results upfront, which negatively impacts the visibility of other travel products. Reducing its dependence on Google, Priceline can incur significant annual savings in its advertising budget going forward.
Kayak has a recognized brand name, and a substantial majority of its users visit the website directly rather than being routed through a search engine. Around 75% of the user queries received on Kayak in the first three months of 2012 was generated by direct visits to its websites, and only 10% were generated from general search engines.
Potential Risk - ITA Software, which was acquired by Google, contributes close to 40% to Kayak's total airfare query results, which accounts for 85% of total searches performed on its website. Kayak agrees that the alternate faring engines solutions do not currently provide the level of comprehensiveness and accuracy that ITA's software offers. In the future, Google might not renew ITA's current agreement with Kayak for any improvement or replacement software, or do so at unfavorable terms, which could negatively impact airline query results from Kayak. (Read Our Full Analysis: Downside Risks To Priceline's Kayak Acquisition Due To Google-ITA)
The Combined Expertise of the Two Companies Can Help Build a Strong Mobile Foundation
With an increasing number of people using mobile devices to go online, we believe the mobile platform offers immense growth opportunity for travel services. Currently, queries received via Kayak's mobile application account for around 14% of the total search queries received by the company.
In Q3 2012, Kayak registered an 87% year-over-year (y-o-y) increase by processing 56 million queries via its mobile applications. Kayak's mobile applications were downloaded 3.1 million times in Q3, a 95% increase over last year, and the company believes that it has a more loyal mobile user base as compared to the PC user base.
Though Priceline does not disclose its mobile revenue in its SEC filings, the company declared in its recent earnings call that it is witnessing rapid growth in its mobile platform. Deutsche Bank estimates that in 2011 around 6%-7% of the bookings from Booking.com, which accounts for a substantial portion of Priceline's revenue, came from the mobile platform [Why Priceline Plucked Kayak, The Street, November 9, 2012].
Developing a mobile platform requires significant costs in terms of design and development. We feel that by leveraging each other's expertise in mobile, Priceline and Kayak can grow its mobile user base even faster.
Priceline Can Add Value to Kayak in International Markets
Kayak receives about 80% of its revenue from the U.S., and has somewhat struggled to retain its foothold in the international markets [Why Priceline Plucked Kayak, The Street, November 9, 2012]. Google's meta-search initiative is considered to be a growing threat, and Kayak does not have enough of an international presence to take on Google's global presence.
On the other hand, with the acquisition of Booking.com, Agoda and TravelJigsaw, Priceline has managed to successfully expand its international gross bookings from 55% of total gross bookings in 2007 to around 78% in 2011. We feel that leveraging Priceline's marketing expertise and rapidly expanding global footprint can fuel Kayak's growth rate in international markets.
Kayak Can Increase Priceline's Competitiveness in the U.S. Market
Though Priceline has been successful in narrowing the gap with its competitors, Expedia continues to account for the highest market share of the agency model in U.S. Under the agency model, OTA acts as an agent in the transaction, passing reservations booked by travelers to the relevant airline, hotel, car rental company or cruise lines. While Expedia accounts for 14.23% of the market, Priceline has an 11.6% market share.
The acquisition of Kayak could increase traffic to Priceline's website, in turn increasing booking transactions. Thus, we believe that the acquisition better equips Priceline to close the market share gap with Expedia in the U.S. market.
In our view, getting Kayak on board increases Priceline's competitiveness in the market. Kayak has developed a world-class technology to facilitate travel searches, and boasts of innovation in building great user interfaces across multiple platforms and devices. With Kayak on board, Priceline has a better chance of reducing Expedia's lead in the U.S. market and also benefiting from other revenue and cost synergies.
Our price estimate of $584 for Priceline is at a slight discount to the current market price.
Disclosure: No positions