Take A Trip To The Travelzoo

| About: Travelzoo Inc (TZOO)
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In this article I would like to talk about a company that has been on my personal watchlist for a few years now. The company, Travelzoo (NASDAQ:TZOO), which some of you may remember from the daily deals bubble, is well off the highs seen around $100 per share in the months leading up to Groupon's (NASDAQ:GRPN) 2011 initial public offering. At the time, anything and everything associated with the daily deals space caught a bid - valuations didn't matter, it was the dotcom bubble all over again.

During this time shares of Travelzoo rose drastically from $40 per share to above $100 as the media, analysts and TV personalities, including Jim Cramer, pumped the stock on television. Well the rise was as quick as the fall shares tumbled all the way down into the mid teens as exuberance for the sector quickly turned into fear as a result of increasing competition in the perfectly competitive market. With the low barriers to entry, every technology company with a decent domain name was vying for market share.

While these crazy swings may have caused some investors great pain, Travelzoo as a company has been carrying on business as usual, making money for that matter. Shares have risen a whopping 56% this year as investors begin to realize the potential ahead. Today, shares sit at $30 per share, a far cry from $100. However, in this article I would like to make the bullish case for Travelzoo within the competitive online travel market. I would like to review the company's recent performance, financial situation and growth potential in the years ahead.

Recent Performance

Earlier this month the company reported strong second quarter earnings. Travelzoo was able to generate revenue of $41.3 million during the quarter, representing 5% year-over-year growth. Earnings per share of $0.34 for the quarter came in above analyst consensus estimates of $0.27 per share. However, EPS was lower than last due to investments in sales force expansion, marketing and the hotel booking platform which we will look at in more depth later on.

If you want to break down the results by segment, revenue in North America was $30.2 million representing a year-over-year growth of 5%. In Europe, revenue was $11.1 million, representing year-over-year growth of 4%. Travelzoo generated $7.8 million in overall operating income of which $1.9 million was from Europe and $5.9 million from North America. Additionally, the company was able to add 1.5 million net new subscribers even with lower than anticipated advertising spending.

Financial Situation

In the case of Travelzoo there isn't all that much to say concerning the company's financial position. Often with smaller companies, investors need to worry about debt and the company's ability to generate sufficient cash flows in order to mange its debt. However, Travelzoo finished the second quarter with $73.4 million in cash, up from $65 million at the end of the first quarter. The nice increase was driven by operating cash flow of $10 million during the quarter. Moreover, the company has successfully operated without any debt weighing on the balance sheet.

Hotel Booking: Problems And Tailwinds

I would like to reference the above photo which was snipped directly from Travelzoo's website. When I tried to book a stay at Green Valley Ranch Resort in Las Vegas I immediately encountered a major booking problem. To book the $59 per night deal, I needed to use the "Click Here" link as seen above in order to connect with the resort's separate website. The user, myself, doesn't have the ability to book the stay directly through Travelzoo, thus creating an additional step for prospective customers. Moreover, if I was using my iPad or other mobile device, I would need to actually call and book the deal over the phone using Travelzoo's offer code "TravelzooJuly." Again, adding another big step for customers and barrier for Travelzoo.

The company is investing heavily into solving this problem during the third quarter Travelzoo plans to spend $1.2 million, in addition to the $900,000 the company spent last quarter, on revamping the booking process. Once finished, customers will be able to avoid extra steps, increasing the simplicity and capabilities within the website. I would expect higher conversion rates on the back of simplicity alone. After all, aren't consumers booking online to avoid the unnecessary steps of conventional hotel booking?

The focus on a online hotel booking infrastructure comes at a good time for the company. Using Google's (NASDAQ:GOOG) Search Interest tools, we can determine the interest for virtually any keyword over the last decade. While I cannot say for certain today, I believe it would be logical to assume search interest and demand are in high correlation. Let's quickly take a look at the search interest, or demand, for "hotel booking" on Google:

The above graph uses a scale of 0 to 100, a score of 100 would represent all time high record search interest for a specific keyword. In this case, "hotel booking" has never seen greater online interest or demand. During the month of July, a score of 100 was recorded amid a strong multi-year upward trend. Google predicts the interest will peak this month before pulling back and registering yet another all time high in the first half of 2014. As with everything these days, consumers are using the internet more often to replace what used to be a long task. Travelzoo's focus on the hotel booking platform comes at the exact time of all time high demand for online hotel booking. I would expect the company to have finished the upgrades by the predicted new high next year.

Mobile Growth

When I was looking at Travelzoo earlier this year I was impressed with the fact the company generated 35% of its traffic via its mobile applications. Today, over 40% of the company's traffic lands at its mobile platform.

Over the last year and a half the company's mobile application has grown in popularity by 582%. Management was able to predict the shift to mobile, over the last few quarters management has looked to make the current mobile platform easier to use for the increasing number of customers looking to book online.

The company's current mobile platform is not suited to accommodate these customers as it lacks the functionality for customers to book directly from the platform. Customers are instead sent directly to the hotel websites, which may or may not offer customers the ability to book from their mobile device. The company described this problem in detail on the conference call:

For example, if a subscriber came and pulled up our mobile app to find a hotel deal this weekend in New York, which undoubtedly we have, it could take several minutes to find the deal and several more minutes to book the hotel on the hotel's website.

For every booking, the subscriber would have to re-enter his details. This limitation stems from the fact that we were designed as an e-mail publisher. With the advent of mobile we see greater urgency to fix these usability challenges.

Time after time again, management has made the case it is missing out on a huge chunk of potential revenues as a result of the inefficiencies. While the company may not be monetizing the mobile traffic today, there is a solution currently in the works. As I mentioned above, a great deal of cash has been sunk on developing a mobile hotel booking platform. The platform will allow users to quickly and easily book hotel nights within Travelzoo's mobile application, while making it easy for hotels to actively update rates. The new platform will allow hotels to quickly upload last minute deals. Who knows, maybe the new platform will take advantage of smartphone push notifications. While we cannot say for sure today, I would assume by simplifying the process for mobile customers, conversion rates will rise, thus helping revenues and lowering additional customer acquisition expenses.

Social Growth

The advent of social media has fueled Travelzoo's popularity on mobile devices. Over the last year the company has drastically stepped up its mobile presence through a mobile application, Facebook site and Twitter accounts.

The rise in Facebook popularity, 465%, will hopefully create a chain reaction for the company in terms of subscriber growth from this channel. As all Facebook users are aware, when one of your friends "likes" something, it shows up on your news feed effectively creating free marketing for the "liked," or Travelzoo in this case.

As of today, the company has 336,869 followers on twitter @Travelzoo. Over the last year and a half this number has grown 69%, impressive to say the least. While the growth isn't in proportion to the growth within Facebook, every subscriber counts as the number of subscribers has remained the key driver to revenue growth. At the end of the second quarter the company had 23 million subscribers. However, with the help of social media the company thinks it can realistically gain another 12 million. Using conservative per subscriber revenue of $7, $245 million in revenues would be generated, a 62% increase from the revenue reported last year. If you decide to use current per subscriber revenues of $7.40, the company would be generating $259 million in revenues.

Pushing vs. Pulling

For the life of the company, Travelzoo has generated revenues by pushing deals on its subscribers through spammy emails. Not a bad strategy, it is making good money. But to take the next step the company is looking to start pulling customers. By this I mean consumers will be going to Travelzoo by themselves to find deals without a push. During the last quarter 21% of local revenues were pulled, significant as pulling saves the company advertising dollars and creates repeat customers, helping customer acquisition costs.

Competition

As I've mentioned previously within this article, Travelzoo operates in a very competitive industry. Just Google "hotel booking" and you will come across a variety of names including Kayak, Booking.com, Orbitz (NYSE:OWW), Expedia (EXPE) and Travelzoo all promising deep discounts on your favorite destinations. Through Travelzoo's website consumers can even search through the competition to book their reservations. Late last week competitor Expedia, owner of Hotels.com, reported a dismal quarter in which revenues and earnings came in lower than anticipated. The poor results were driven in large part to a 33% increase in marketing costs and greater competition within the industry. While the entire travel space may trade lower off these results, investors must realize where one is losing someone else is gaining.

The way in which Travelzoo can differentiate itself is through the daily deals style of business it already uses. The majority of the competition already has a direct booking platform nearly identical to the one I believe Travelzoo is creating. However, these websites seem to cater to the traveler who already planned and chosen their travel dates. With Travelzoo's model of selling hotel vouchers, the company is targeting a different consumer - the consumer who may not be planning a trip but all the sudden sees a deal for a trip within a certain period of time and wants to buy it. In the years ahead I would expect to see further consolidation within the industry to keep marketing costs manageable. Similar to the airline industry, most consumers are looking for just the best deal on the market. Increased consolidation would allow the larger firms greater pricing power from the hotels themselves as there are less options available.

Risks

  • Rising competition within the online hotel booking space may raise cost per click expenses through search engines.
  • Low barriers to entry - there are an array of companies offering local deals to consumers.
  • Priceline offers consumers the option to book directly though the website already.
  • If the hotel booking platform is delayed further, the company may miss out on market share - thus would need to spend more down the road to remain relevant.
  • Travelzoo isn't a household name for many.
  • Over-expansion of the workforce may hurt margins should the company's growth slow.
  • Economies of scale in favor of larger firms could put Travelzoo in a tough pricing environment.

Conclusion

I think you can buy Travelzoo here. The company has positioned itself to benefit from a few key tailwinds. Hotel booking, mobility and social marketing will all be the driver of revenues and earnings in the years ahead. While small, $455 million in market cap, the company is generating significant profits, funding the future without debt, and sitting on a nice chunk of cash. I know we as investors are not supposed to buy a company on the hopes of a buyout, but I feel one of the larger players in the space may be interested. Consolidation within this space has been trending as of late.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in TZOO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.