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With a 7% annual growth in its Q1 2013 revenues ($42.2 million), Travelzoo (TZOO) continued the growth momentum gained in Q4 2012 as it witnessed higher spending by vacation packagers and growth in the Getaway hotel deals, both in North America and Europe. Though the continued investment in expanding its sales force, increasing subscriber marketing and development charges for the hotel booking platform led to a decline in Travelzoo’s current operating income, we believe the above measures are important to drive its future growth.

Travelzoo witnessed only a marginal rise in 2012 revenue as certain factors - the challenging economic situation, airline consolidation, lower spending by online booking engines and increasing operating expenses - dampened its short-term growth. Nevertheless, the company maintained a strong financial position with positive cash flow, growing cash and no debt.

We believe that a strengthening hotel business, growth in mobile traffic and social media integration places it in a good position to leverage future growth in the online travel industry.

Introduction Of The Hotel Booking Feature To Drive Growth

Believing that its hotel search offerings were not meeting the needs of users and hotel owners, Travelzoo has been investing to build its own hotel booking platform and will launch the same later this year. The hotel booking platform will enable users to book hotels directly via Travelzoo’s website or through mobile products, allowing suppliers to promote deals in a more flexible manner; e.g. loading a last minute rate for a hotel will become much easier compared to Travelzoo’s current solution.

The hotel booking feature is currently being tested on Perfect Escape’s website, which was acquired by Travelzoo last year and earned $400,000 in gross bookings in Q1 2013. The booking feature will initially be offered on Travelzoo’s websites, but the company intends to roll out the platform across all products by the second half of 2013.

Additionally, Travelzoo aims to aggressively ramp up the number of hotels and deals offered in the latter part of 2013. Hotel voucher sales have increased by approximately 48% in the last year and we believe the introduction of the booking feature will continue the growth momentum further as well.

Local Deals Remain An Attractive Business Opportunity

Owing to a declining number of vouchers sold per deal and lower take rates, Travelzoo’s Local Deals business suffered in both regions, offsetting growth from other divisions. On a q-o-q basis, North America and Europe reported 4% and 8% lower revenue from the Local Deals segment, respectively. Though Travelzoo’s increasing presence in new markets led to a higher number of published deals, the positive impact of the same was offset by a decline in average vouchers sold per deal.

With increasing Internet penetration, the rise of social commerce and the expanding online travel market, the deals business has immense long-term growth potential. However, while the advantages of entering this market are apparent, the low entry barrier pitches Travelzoo against a large number of existing competitors as well as potential new entrants in the market.

Nevertheless, we think Travelzoo’s entry in the Local Deals space is a good long-term strategy and believe that the company has the capability to retain its competitiveness in the deals business. So far, only a small proportion of local businesses advertise online. BIA/Kelsey, a media advisory firm, estimates that the local businesses’ online marketing spend will increase to $35 billion by 2014, compared to approximately $20 billion in 2010. [1]

An increasing investment in building a strong sales force and its focus on high quality deals could help drive future growth in Travelzoo’s Local Deals Business. Additionally, its existing hotel relationships and growing subscriber base for its other products, like the Top 20 Newsletter, could give the company an edge over its competitors.

High Operating Expenses To Drive Future Growth

An expanding sales force, increasing subscriber base and investment in new product development has negatively impacted Travelzoo’s bottom line. While this has restricted its short term growth momentum, we believe the investment can accelerate revenues in the future by increasing the number of business from which Travelzoo publishes deals as well as expanding its audience base. In its earnings call, the company mentioned that the increasing productivity of the sale personnel hired last year helped it reach a wider audience and publish more deals which in turn contributed to higher revenues.

Rising headcount costs, increased subscriber marketing, legal and professional fees and development costs for the hotel booking platform will further increase Travelzoo’s expenses this quarter. It estimates an investment of $900,000 for the booking engine alone with no immediate revenue benefits from the platform.

While the increase in investments might be detrimental for Travelzoo’s short-term growth, we expect it to play a crucial role to spur the company’s long-term top-line growth. Going forward, we expect the expenses to reduce, and as Travelzoo plans to focus on growth and improved productivity, we estimate margins to stabilize in the long run.

Disclosure: No positions.

Source: Travelzoo Shows Impressive Growth Despite Macro Environment