As a value investor, I am constantly on the lookout for companies that are currently under-priced in the market relative to their future prospects for growth. As part of my search for such companies, I pay close attention to ones which have recently had a large drop in price due to a specific negative event. Often times such drops could be a good entry point to take a position if you believe the long term prospects are still good and the bad news is just a short term difficulty.
One such company that came on my radar the end of last week was Travelzoo (TZOO). On Friday morning October 12th the company issued a warning statement that its 3rd quarter sales and earnings would be lower than expected. The company expects sales to be around $35 million with earnings of $0.21/share. Both figures were lower than analyst estimates - about 11% and 23% respectively. The market responded on Friday and the stock was down about 14%.
If you happen to have read some of my previous focus articles, you may know that I often use a 10 point system to evaluate companies. In this article I will evaluate Travelzoo. I have scored the company a 7 out of 10 in my system. As I advocate to only consider buying a company which scores an 8 or higher, Travelzoo does not make the cut and I do not believe it presents a compelling value for several reasons which I'll outline below in detail.
Note: For more information on my investing philosophy please check out my profile or website linked above.
Travelzoo is an internet travel company which publishes deals from travel and entertainment companies. The company was founded in 1998, and has a market cap of about $320m. It operates travelzoo.com, as well as several other websites in various countries in North America and Europe. The company also operates fly.com and SuperSearch, which are search engines to help customers find the best flights and travel packages. More than 2000 companies use Travelzoo to advertise travel and entertainment packages and deals. There are 24 million subscribers to the company's newsletters as well as millions of website users.
Circle of Competence
For any company that I evaluate, I first assess how competent I am in understanding the business. As part of my 10 point system referenced above, I assign a value between 0 and 2 points for this. I won't go into detail of my methodology here, but for Travelzoo I have assigned this at 75%, or 1.5 points. I'm a regular user of travel search engines and deal sites such as Travelzoo, and I'm also an IT professional and very familiar with internet technologies.
Score: 75% - (1.5 out of 2pts)
Magic Formula Screen
For those who are not aware of what the "magic formula" is, this is a stock ranking system created by value investor Joel Greenblatt. The methodology was first described in Greenblatt's The Little Book that Beats the Market. Details about his methodology including the screens can be found at his website. I won't go into detail here on the methods described in his book, but the basic premise is to find companies with a high earnings yield (measured by EBIT/EV) relative to the Return on Invested Capital (ROIC) that they produce. So you are screening for "good" companies at "bargain" prices. If you check out the website above you can sign up for free and view the current screens. Following my philosophy, I often check the top 50 stocks over $50 million in market cap and the top 50 over $1 billion in market cap as a starting point for stocks to analyze.
After the drop in price this past week, Travelzoo has recently entered the top 50 over $50 million screen. This tells me that the company has very good internal return rates based on results of the previous year, and also that the market price is very cheap relative to the earnings the company generates. In this sense, the screen has been good in alerting me of the price drop. However the screen is looking at last year's results, so now we need to examine the business prospects and other factors to see whether the company deserves to be cheaply priced or not.
Score: 100% - (2 out of 2pts)
Online travel sales continue to grow much faster than country GDP rates. This report states that even in the US where the market is quite mature already, online travel sales will grow at a CAGR of 7.2% from 2011 to 2016. Today more than 38% of travel planning in the US is done online, and some travel agents predict that in the coming 10 years this could increase substantially to nearly 75% in the US market. In recent years starting with the great recession in 2008 - 2009, growth rates slowed considerably to single digits. However now with the explosion in smartphone and tablet adoption many expect growth rates might be faster than previously anticipated.
I think in general the business prospects for this industry are still quite good, there will be overall decent growth rates in the coming 5-10 years. Indeed the few analysts that cover Travelzoo have lofty growth estimates of 20% year over year. Similar estimates also exist for the main competitors.
Score: 100% - (1 out of 1pt)
I believe it is important to assess how well a company's management has shareholder interests in mind, as this always can have a large impact on the return you will receive for your investment over time. In the case of Travelzoo, the company does not pay a dividend. There is however very high levels of insider ownership, over 50%, which is generally a positive to better align the interests of management with common shareholders. In this particular case, the founder Ralph Bartel owns 53% of the company and effectively controls the company as he can elect the board of directors himself. This could be a risk for common shareholders as they do not have much say in the strategic direction of the company. Another point is that the company does from time to time repurchase some stock to offset equity compensation given to management, but I would like to see a more consistent and sustained effort of share repurchases. The repurchases have been small and inconsistent.
Score: 50% - (0.5 out of 1pt)
One of the bigger issues I have with Travelzoo is the economic moat around the business appears to be quite weak. There is a lot of competition in this space, and Travelzoo is not the largest player. Expedia and Priceline are much larger businesses and have stronger competitive advantages due to scale. Travelzoo recently launched the Local Deals service as an additional growth avenue, but this service is very similar to what Groupon (GRPN) and Google (GOOG) offers. As with any internet based business the barriers to entry are quite low as well so more competitors can pop up at any time. The company states in the 10-K section that they also compete for advertising dollars with internet portal sites such as MSN from Microsoft (MSFT) and Yahoo (YHOO).
Recently I wrote in an SA article about Apple (AAPL) that one of the keys to having a competitive advantage for consumer technology companies is to provide a product which has compelling usability. Generally, this is what has propelled the most successful internet companies to grow their user bases substantially faster than the competition. Some excellent examples besides Apple would be Facebook (FB), Google, and Amazon (AMZN). These websites were from the start very user friendly for the average consumer and they caught on because the usability was obviously far superior to competitors. Although Travelzoo has a decent website, and their mobile version is also quite OK, when I clicked around a bit and did some searching, I did not find it to be substantially different or better than any of the competitors. With this lack of visible economic moat around the business, it is very hard to know for sure how well the company will fare in the coming 10 years - this is surely a negative against my philosophy to avoid too much downside risk.
Score: 0% - (0 out of 1pt)
With this criteria, I look at whether there are any risks to the financial health of the company. Travelzoo has a debt/equity ratio of 0. This is one of the bigger attractions to the company, as it has been debt free the past 10 years. There is also $54m in cash.
Score: 100% - (1 out of 1pt)
I like to look at how predictable and dependable a company's earnings have been in the past. Generally, I do not like to invest in wildly cyclical businesses.
Travelzoo has seen some fluctuation in earnings over the past 10 years. Sales have increased substantially from $9.85m in 2002 to $148m in 2011. However earnings as well as cash flow have been much less predictable. Earnings were as high as $1.01/share in 2006, but dipped all the way to $0.20/share in 2011. It should be noted that the outstanding share count has remained relatively flat during that period as well. This unpredictability makes it much more difficult for me as an investor to feel comfortable making accurate projections of future earnings.
Score: 0% - (0 out of 1pt)
To calculate whether the current price constitutes a sufficient margin of safety, I have compared the current valuation of Travelzoo against its major competitors in terms of EV/EBITDA. Normally I would do a DCF model to come up with an intrinsic value for the company, however with the unpredictable earnings of the past few years I find the growth rates very difficult to estimate in this case.
Here is how the company compares to its main competitors:
Travelzoo is definitely priced cheaper than its competitors by a large margin. Interestingly, if you look at the analysts estimates for these 4 companies, the 5 year EPS growth estimates are all similar. Travelzoo, Priceline and Kayak are all around 20% yoy growth, and Expedia is 13%.
Purely from a valuation perspective, Travelzoo is attractively priced.
Score: 100% - (1 out of 1pt)
Travelzoo has scored a 7 out of 10 in my system, so I will not recommend it as a buy. I only consider to buy companies that I score at least an 8.
|Circle of Competence||1.5||2|
|Magic Formula Screen||2||2|
In conclusion I believe that Travelzoo's biggest weakness is that it lacks any compelling competitive moat. Although the general prospects for growth in the industry are quite good, I don't have enough confidence in the business to be sure that it is well positioned for the long term. Also I do not like the unpredictable earnings history, which does not match well with the solid revenue growth. In my opinion there are many better companies out there which are more worthy of your investment dollars.