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Online travel is quickly taking on a new cult-like status among investors, with word of a major new funding for vacation rental site Tujia. This latest fund-raising frenzy in online travel looks very similar to what happened in group buying about 4 years ago, when investors pumped billions of dollars into a wide range of money-losing start-ups. Internet watchers will know that many of those companies later went bust, raising the prospect that a similar fate could be waiting for the online travel sector.

I've followed the Chinese Internet now for more than a decade, and during most of that time the online travel space was dominated by 2 companies: sector leader Ctrip (Nasdaq: CTRP) and eLong (Nasdaq: LONG), and distant second backed by U.S. travel giant Expedia (Nasdaq: EXPE). But then investors and entrepreneurs started to discover the space around 3-4 years ago, betting on the rapid rise of a new generation of newly mobile Chinese business and leisure travelers.

Now Tujia has officially joined the ranks of major players, with word that it has received a hefty $100 million in third-round funding (English article). Money in this latest round came from the company's 7 existing investors, most of whom are domestic and include names like Qiming and China Broadband Capital. Ctrip was also among the investors, and so was U.S. rentals site HomeAway (Nasdaq: AWAY).

Many of the new companies springing up are somewhat niche-oriented, unlike Ctrip, eLong and recently listed Qunar (Nasdaq: QUNR) that are more general travel agents providing air tickets and hotel reservations. Tujia is a good example, focusing on the market for hotels and tour packages in popular vacation destinations.

Tujia is just the latest company to raise big money in the online travel space. Qunar kicked off the triple-digit funding with its IPO late last year, in which it raised $167 million, even though it is still losing money. Another travel site Tongcheng received 500 million yuan ($80 million) in February (previous post), and yet another site Tuniu (Nasdaq: TOUR) raised $117 million with an IPO last month (previous post). E-commerce giants JD.com (Nasdaq: JD) and Alibaba have also announced plans for their own online travel sites over the last 2 years.

I completely agree that China's travel market is experiencing rapid growth, which is apparent in the constant stream of news stories about Chinese traveling abroad. But current growth rates of 20-30 percent probably can't support this much faster growth in online travel services.

Group buying is a good example of what can happen when Chinese Internet sectors suddenly get too much investor attention. That sector, boosted by the sudden emergence of U.S. giant Groupon (Nasdaq: GRPN), saw an explosion of new entrants as investors pumped hundreds of millions of dollars into names like Gaopeng, 55tuan, Meituan and LaShou in 2010 and 2011.

But after the initial hype wore off, many problems emerged due to lack of regulatory oversight and stiff competition. As a result, most companies have closed shop or been purchased for bargain prices, costing investors millions of dollars in lost money.

I suspect we could see something similar in the online travel space in the next few years, though perhaps the effects won't be quite as dramatic since barriers to entry are a bit higher. China's slowing economy is almost certain to put a damper on demand, which will put pressure on all these new online service providers. Among those, none of the newer companies is earning a profit yet, and that's unlikely to change due to stiff competition and the slowing growth. As a result, look for some difficulties ahead in the space over the next 3 years, including a likely wave of mergers and even closures.

Bottom line: A new mega-funding by Tujia is the latest sign of overheating in the online travel space, with a wave of consolidation likely to follow in the next 2-3 years.

Disclosure: No positions

Source: Investors Favor Online Travel With Tujia Funding