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Shares of Travelzoo (TZOO) lost almost 15% on Friday. The global internet company, which focuses on travel, entertainment and local deals, reported preliminary third quarter results.

Third Quarter Results

Travelzoo reported preliminary third quarter revenues of $35.0-$35.5 million. The revenue outlook compares to third quarter revenues of $38.7 million in 2011, and 2012's second quarter revenues of $39.4 million. Analysts expected the company to report third quarter revenues of $38.9 million. As such, revenues are expected to fall 9.0% on an annual basis, and 10.6% on a sequential basis. The warning of sequential revenue declines exceeding 10% is severe, given that many of Travelzoo's competitors, continue to see strong revenue growth.

Travelzoo expects to report third quarter earnings of $0.20-$0.22 per share. This compares to earnings of $0.36 in the third quarter of 2011, and earnings per share of $0.45 in the second quarter of 2012. On average, analysts expected the firm to report earnings of $0.27 per share.

The company furthermore announced that it is in negotiations to acquire a hotel booking website.

Travelzoo's current offering differ from offerings of other online travel agencies. Hotels first need to be tested and approved by Travelzoo's own experts, thereby limiting the choice to customers.

CEO Chris Loughlin commented on the preliminary report, "We continue to be positive about our long-term growth strategy, but we have found our hotel search offering and the group-buying voucher model not meeting the needs of hotels and users well enough, and therefore plan to adjust our product offering."

The company has over 25 million subscribers across the globe and it publishes deals for more than 2,000 travel and entertainment companies.

Valuation

Travelzoo ended its second quarter of its fiscal 2012 with $54.2 million in cash and equivalents. The company operates without any debt for a comfortable net cash position. Travelzoo announced in July that it will repurchase roughly 1 million shares with its strong cash balance.

For the first six months of 2012, the company generated revenues of $78.7 million. The company reported a net profit of $11.0 million, or $0.69 per diluted share. Based on the preliminary third quarter update, the company is on track to report annual revenues around $150 million. Annual earnings could come in around $17-$18 million, or around $1.10 per diluted share.

After Friday's sell-off, the market values the firm at $320 million. Excluding the net cash position of $55 million, this values the operating assets at $265 million. This implies a valuation of 1.8 times annual revenues for the operating assets, and 15 times annual earnings.

Travelzoo does not pay a dividend.

Investment Thesis

Year to date, shares of Travelzoo have fallen some 20%. Shares started the year at $25 and quickly peaked at $30 per share in January. Shares gradually lost ground hitting lows of $20 during the summer months. In recent weeks shares recovered to $24 per share, but fell back now exchanging hands at $20 per share.

Over the past five years, shares are trading largely unchanged, but have witnessed tremendous volatility in the meantime. Shares traded as low as $5 in 2009 and almost hit $100 per share in 2011. Between 2008 and 2012 the company has aggressively grown its business. Revenues almost doubled from $81 million in 2008, to an expected $150 million this year. The company turned a $4 million loss for 2008, into an expected profit of $17-$18 million in 2012.

Travelzoo employs a different strategy compared to some of its major competitors which include Expedia (EXPE), Kayak (KYAK) Priceline.com (PCLN) and Tripadvisor (TRIP). The company is much smaller in size compared to these competitors and only includes offerings based on certification of its own "travel experts."

What's worrying is that the company guides for revenues to fall over 10% both on a sequential basis, as well as year-on-year. As the company admitted itself, the strategy is not working. The failure of Travelzoo's strategy is the main reason behind the plans to buy a hotel booking website. Given the much smaller size of the company it is questionable whether it is able to buy a respectable online name. Furthermore, there is always the matter of making an acquisition at a right price.

While the company's valuation might look relatively appealing to competitors, shares are dangerously expensive. Given the very competitive field out there, the company runs the risk of getting killed by competition. I doubt the company's ability to turn the tide.

I am staying on the sidelines. An outright short position might be risky as a major competitor might be willing to acquire Travelzoo in order to boost their offerings.

Source: Travelzoo - No Holiday For This Travel Company