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Shares of Kayak Software (KYAK) rose sharply in after hours trading on Thursday. Shares of the online travel company hit all time highs of $39 per share after its larger competitor Priceline.com (PCLN) announced its intention to acquire the company for $40 per share.

The Deal

Priceline.com announced on Thursday after the close that it will acquire travel company Kayak. Priceline will pay $40 per share in cash and stock. The deal values Kayak at roughly $1.8 billion, or $1.65 billion when excluding the net cash position of Kayak. Priceline will pay $500 million in cash and the remainder of the deal value will be paid in stock and stock options.

Priceline intends to boost the company's global reach and expertise by incorporating Kayak into its own business. Kayak has strong technological capabilities and a track record of profitable growth, as well as popularity among consumers.

CEO and co-founder Steve Hafner commented on the deal, "Paul English and I started KAYAK eight years ago to create the best place to plan and book travel. We're excited to joint the world's premier online travel company. The Priceline Group's global reach and expertise will accelerate our growth and help us further develop as a company."

For its fiscal year of 2011, Kayak generated sales of $224.5 million. The company reported a net profit of $9.7 million.

Kayak reported its third quarter results for 2012 today, indicating that revenues for the first nine months of the year came in at $228.9 million, up 34.2% on the year. Kayak reported net income of $19.4 million for the period. At this rate the company is on track to generate annual revenues north of $300 million. Net income for the full year of 2012 could come in around $25-$30 million.

Excluding the $178 million in cash, equivalents and marketable securities, the deal values the firm at roughly $1.65 billion. This values the operating assets at approximately 5.5 times annual revenues and roughly 60 times annual earnings.

The deal is already approved by the board of directors of both companies. The deal is furthermore subject to Kayak's shareholder approval, customary closing conditions and regulatory approval. The deal is expected to close in the first quarter of 2013.

Valuation

Priceline.com ended its third quarter of its fiscal 2012 with $4.7 billion in cash, equivalents and short term investments. The company operates with roughly $1.4 billion in convertible debt, for a net cash position of $3.3 billion. As such, financing of the $1.8 billion deal should be no problem, as the cash portion of the deal is just $500 million.

For the first nine months of its fiscal 2012, Priceline.com generated $4.1 billion in revenues. The company reported net income of $1.1 billion, or $22.05 per diluted share. At this rate, Priceline is expected to generate full year revenues of $5.3 billion.

Shares of Priceline.com are falling 2% in after hours trading, valuing the firm at $30.7 billion. Excluding the net cash position of $3.3 billion, operating assets are valued at $27.4 billion. Operating assets are valued at 5.2 times annual revenues and roughly 20 times annual expected earnings for 2012.

Investment Thesis

Shares of Priceline are trading with gains of 32% so far in 2012, driven by strength of the online travel industry. The strength in shares of online travel companies induced Kayak to make its public debut in July of this year. Shares of Kayak were eventually offered at $26 per share, up from an initial price range of $21 to $25 per share. The $40 offer represents a 74% premium compared to the midpoint of the initial guided price range.

The deal represents a modest addition to Priceline's operations, adding roughly 5-6% in annual revenues. The deal makes sense for Priceline and seems fair on the basis of a revenue multiple. Priceline.com values Kayak at 5.5 times annual revenues, compared to a valuation of 5.2 times for the company itself. The difference is the superior profitability of Priceline.com which reports net margins exceeding 25%, compared to a net margin of 8.5% for Kayak. As such, the deal values the firm at 60 times annual earnings, compared to a multiple of 20 times for Priceline.com

The deal is a nice addition for Priceline.com and a 2% decline in after hours trading seems overdone. The deal is not that significant in terms of revenues or profits, but adds significant technology capabilities to Priceline. Furthermore, Kayak's revenue growth of 28.5% in the third quarter, surpassed Priceline's third quarter revenue growth of 17.4%.

Shareholders in Kayak are most likely happy to tender shares at all time highs, after the company has been public for a period of a mere four months.

The deal is not transformational and I stay on the sidelines as I am concerned about long term margins. Priceline's revenues make up 21% of gross bookings, and I expect this ratio to fall over time amidst increased competition and price consciousness by consumers.

Source: Priceline.com Acquires Kayak After A Mere 4 Months As A Public Company