Cliffside Research is pleased to announce a compelling short thesis on Travelzoo, Inc. (NASDAQ:TZOO). TZOO is overvalued by at least 50% and long term, we make the case that the stock could approach zero. For the entire "strong sell" thesis, please visit our website.
TZOO came public during the tech boom days in 1998. The stock has been on a roller coaster ride ever since, twice breaching $100 per share in a burst before eventually crashing back to Earth just as quickly. Its "technology" is old, outdated, clunky and at times difficult to use. This is directly the result of years of under-investment as it has strictly run the business to maximize cash flows. We are big fans of maximizing cash flows but in TZOO's case, it has maximized them for short-term gains and to the long-term detriment of the business. This strategy had worked for several years as the business was able to grow revenue despite the lack of unique technology but in 2013, its revenue growth run ended and now it's time to pay the piper. The company is now attempting to return to growth via a hotel booking platform but we believe this strategy will fail.
How did it get here? Most executive management teams find themselves reassuring analysts while walking down overly aggressive expectations. Often it's not a matter of growth, but investment in the future of the company that delays the near-term earnings euphoria for long-term earnings sustainability. TZOO finds itself in the opposite camp. The company has largely been run profitably over several years but it has mainly relied on what worked in 1998 to do so, an advertising-based vacation deals email newsletter. It calls those who sign up for its newsletters "members" but its members are mainly just an email distribution list. While the competition has promoted and invested in product to improve functionality, ease of use and increased engagement on multiple platforms for the consumer, TZOO chose to mainly focus on its vacation deals email list. Despite more recent attempts to push into mobile apps and social, this simple email list is still the major driver of revenues even now in 2016. First, we'll review TZOO's competitive position and then we'll breakdown current sources of revenue.
Blurred Lines - Where Does TZOO Fit?
Within the travel category, there are four or five major buckets a company can fit in. The categories include online travel agent (OTA), customer review, metasearch, back-end systems and Internet advertising. Increasingly, they all do a little of each. Priceline (NASDAQ:PCLN) and Expedia (NASDAQ:EXPE) are generally considered OTAs and they currently dominate the category. However, they are also major players in all the other categories. For example, Priceline's Kayak and Expedia's Trivago would be examples of metasearch sites. Metasearch sites search several different travel providers for the best price, but due to consolidation, the options increasingly are dominated by PCLN and EXPE. TripAdvisor (NASDAQ:TRIP) is a customer review site, but it now has rolled out its own hotel booking platform and advertising largely drives its revenue. TRIP is also a metasearch provider. On the back-end, we include B2B service providers, hotel management systems and the like. PCLN is increasingly a major player in this category as it looks to build deep, sticky relationships with the supply base. Then there's Airbnb (Private:AIRB) and the "home sharing" category, which is a whole other ball of wax but clearly is another competitor in hotel booking.
As you might imagine, these industries are tech-heavy, highly competitive and extremely innovative. TZOO is none of that. TZOO is loosely considered a media publisher, but really it is mainly known as a travel package and local deals advertising platform. It distributes an advertising newsletter to an email list. The model hasn't changed much in its 18 years. It has added mobile apps and is attempting to monetize social but if it is having major success monetizing these options, it has been keeping that secret to itself.
For example, mobile apps have become a major component of travel bookings. Several travel apps rank well above TZOO. In the travel category of the newly released iOS 10, there are dozens of travel apps available. TZOO's app is not featured at all. An app store search for "travel," a word that is in its name, has it listed as the 25th option. A search for "hotel" lists it as the 38th option.
TZOO's three sources of revenue are travel, search and local.
Travel revenue includes travel publications, which consists of its Top 20 newsletter, Newsflash email alert service, websites, and network revenue consisting of third-party websites that list TZOO published travel deals. In addition, "local getaway" vouchers and the hotel booking platform revenue also fall in the travel category. When TZOO references "members" it is referring to the 28.9mil email accounts that have signed up for its email newsletters, mainly the Top 20 newsletters. Although it is unclear exactly what percent of this division is driven by advertising revenue, it's safe to assume that the vast majority is from advertising. This division is the foundation that the business was founded on in 1998.
Travel has been in a steady decline for the company since 2014. Major drivers of the decline include declining advertising rates due to the move to mobile, lost customers, increased competition and FX. With the exception of FX, we believe the trends impacting it are long term in nature, not likely to reverse course and cause the company to be seen as increasingly irrelevant to advertisers and consumers alike.
Currently, TZOO is rolling out its hotel booking platform. It first began rolling out the platform in Q2 of 2014. The rollout has been extremely slow and cautious. To date, it still has not rolled out the platform worldwide. Success in the hotel booking platform is critical for TZOO. It has been extremely guarded about the platform and has not released any meaningful information regarding the percent of revenue it now represents. The company expects its hotel revenue to increasingly shift to this platform over time. We believe this is a major transition for the company and an extremely negative development for several reasons. Here are five key reasons.
- The shift to the hotel platform appears reactionary to deteriorating market conditions in advertising and voucher sales. It's essentially an act of desperation.
- The company doesn't have experience in hotel booking, hence the very slow rollout.
- Expedia and Priceline dominate the category. Both are much larger players and with the recent entry of TripAdvisor and Google (NASDAQ:GOOGL) into hotel booking, competition has only increased.
- Due to the competitive nature of the space, margins will be lower than TZOO's existing margins.
- The company has admitted the shift will cannibalize advertising and local getaway revenue. We fear this doesn't add revenue, but simply slows the decline at best.
Search revenue includes SuperSearch and Fly.com pay-per-click advertising revenue. These products fall in the "metasearch" category with competitors like Priceline's Kayak or Expedia's Trivago and others. Search has been in decline, and the company expects the decline to continue. The decline has been driven by intense competition and the move to mobile, which the company has found difficult to monetize. TZOO has been scaling back spend on traffic acquisition for several quarters. As a result, the search product is increasingly irrelevant to the marketplace.
Local revenue includes local deal vouchers and entertainment non-vouchers. Local deals and the local "getaways" product (included in travel revenue) were the main drivers of increased revenue beginning in late 2010 through mid-2012. These products compete with providers like Groupon (NASDAQ:GRPN) and Living Social. In yet another example of a reactionary mindset, we believe TZOO entered this space due to competitive pressure. In mid-2012, local revenue began a long, steady decline that continues today. The decline is driven by several factors including competition, declining demand and decreased take rate (commission) earned from merchants for vouchers sold.
TZOO has claimed in the past that the segment has suffered from irrational competitors that are offering money-losing deals in local. TZOO has chosen to focus on profitability at the expense of lost market share. We believe this is the correct decision, but it means this division is unlikely to be a driver of meaningful revenue or income growth going forward.
Changing consumer habits have also impacted local revenue. As competition has increased and consumers have acclimated to the "deals" voucher concept, they are increasingly choosing to purchase vouchers at the time they are planning to use them rather than on impulse. This change in consumer mindset from "push" to "pull" has also been blamed for the decline.
Source: SEC Filings & Cliffside Research
Source: SEC Filings & Cliffside Research
The APAC division was acquired in Q3 2015. The chart below restates revenue as if APAC had been acquired in Q1 2013 for comparison purposes. We note that no region is experiencing growth and all are in long-term decline. Total Revenue and North America revenue peaked in 2013 and show no signs of recovery. The Q1 and Q2 uptick are purely seasonal in nature and down year over year.
Source: SEC Filings & Cliffside Research
Terrorism Likely Impacts Q3 & Q4 and Beyond:
In its most recent quarterly call, the company acknowledged that terrorism had an impact on its quarter and it expects the impact to be greater in both Q3 & Q4 this year. CEO Holger Bartel explained in great detail on the call how their business is impacted in two ways. First, in places where there have been terrorist activities like France, Belgium, Germany and Turkey, the advertisers don't want to advertise travel packages. Interestingly, Turkey happens to have been a very popular destination for European travelers. Mr. Bartel stated that, "a year or two ago, Turkey was probably one of the most popular destinations promoted in our UK Top 20, now it happens very rarely." The UK represented 19% of TZOO's revenue in 2015, so this is significant. TZOO, wisely, is also not looking to advertise high-risk areas like Egypt, for example.
The second impact comes from its members who, of course, are less interested in traveling to those destinations, but are instead choosing destinations that are perceived as safe like Spain and Portugal. These popular destinations are very busy and it's far more difficult for TZOO to find good deals in these locations. In fact, these destinations are now so popular that the locals in some cases have written graffiti encouraging tourists to leave and politicians are considering several measures to cap tourism. Since TZOO is mainly known as a last-minute travel deal provider, this is further hurting its business. Unfortunately, due to recent events, New York City also may be an area vacation travelers increasingly avoid. Travel to the US by foreigners has been one of the areas of strength for TZOO and New York City is one of the top destinations.
Ultimately, we believe none of these developments are welcome for small travel-focused operations like TZOO that are likely to be impacted more than larger, diversified organizations. We argue that when vacationers feel both fearful to travel to some regions and unwelcome in others, it is more likely to stay home. We feel this trend will likely continue as consumers opt for more "staycations" in coming years. These cheaper packages likely won't generate the same kind of advertising rates and commissions for TZOO, further widening the gap to its much larger competitors.
Google Search As A Predictor of Revenue:
Searching for "travelzoo" on Google appears to be a good predictor of TZOO's revenue and can be found here. Google searches for "travelzoo" peaked in June 2011. TZOO's revenue peaked in the March quarter of 2013 and, as we mentioned, has been declining since. There are several points of note with the charts below. The blue line represents the percentage of searches for "travelzoo" vs. peak searches in June 2011. As you can see, "travelzoo" is currently about 35% of peak. All the annual peaks tend to land around June.
There is an interesting seasonal "M" pattern that is very consistent. The left peak of the "M" is usually December and the right peak is usually June of the following year. As searches for "travelzoo" were increasing from 2004-2011, the right peak of the "M" tends to be higher than the left, indicating increased search momentum for "travelzoo." Once searches peak in 2011, the left side is higher, indicating searches for "travelzoo" have lost momentum. We believe this is directly the result of increased competition and the move by consumers to mobile devices. Relative to peers, TZOO is a very small player in travel. It will be very difficult for the company to regain momentum. While its business and by extension its relevance to advertisers has shrunk, its much larger competitors have kept growing. This further widens the gap and makes it that much more difficult for TZOO to return the business to growth.
It's also important to note that much of its revenue growth in recent years came from the launch of local deals in late 2010 and local getaways in 2011 to compete with Groupon and Living Social. Entry into these categories pushed revenues to the peak in March 2013. Local deals and local getaways are no longer a driver of the business but a drag on revenue. It does not appear that this trend will improve in the near term as management appears focused on slowing the bleed in its core travel advertising segment, which represents the bulk of revenue.
We also note that the re-acquired Asia Pacific division has helped boost its revenue in recent quarters. We provide the bright red line to show what revenue would be without the acquisition to show that the underlying business remains on a downward trend. We are now coming upon the weakest part of the year for TZOO (Sept. - Nov.). This will add further pressure to declining revenues.
Source: Google Trends, SEC Filings, Cliffside Research
Below, we provide a second graph that contains the same data as above but zoomed in showing 2010 to present. The downward trend in Google search for "travelzoo" remains firmly in place and likely will get worse as we now begin to enter the seasonally weakest part of the year for TZOO in addition to the terrorism impact. As an example, we highlight the recently completed month of August compared to August 2015. It is clear TZOO still has not turned the corner. The revenue data ends with the June quarter. We fully expect Q3 & Q4 revenue to follow the search trend downward.
Source: Google Trends, SEC Filings, Cliffside Research
Entry Into the "Local" Division Didn't Save It:
In the 4th quarter of 2010, TZOO had high hopes for its local deals business as it was playing catch-up to Groupon and others. In its presentation for that quarter, it had a slide that indicates the local deals opportunity to be at least $110mil in annual revenue, or a nearly doubling of its annual business from 2010. At the time, it said revenue per member, or subscriber as it called them back then, could reach $14.30.
You can see in the chart below that what happened instead was an initial improvement to $8.19 in the 3rd quarter of 2011 followed by a steady decline. In the most recent quarter, revenues per member hit a new low of $4.77. This figure will likely continue to decline over the seasonally weak Q3 and Q4.
Source: SEC Filings & Cliffside Research
While revenue per member is continuing a steady decline, average cost per acquisition of a new member is steadily increasing.
Source: SEC Filings & Cliffside Research
True Cost of New Members Far Higher Than Reported:
The chart above doesn't take into account member churn. Member churn is the result of email unsubscribes by members, or periodic list maintenance for bad email addresses. When we account for churn, or net new members after subtracting out members that are churned out of the base, the cost per net new member is much, much higher. We believe this is a critical discovery for investors in TZOO but it gets worse. The chart also shows that while the company is spending more for net new member adds, it is actually adding far fewer net new members. In fact, in the 4th quarter of 2014, it lost more members than it added despite spending nearly $2mil by our estimates. We believe this was the first time in TZOO's history that it had net negative member adds for a full quarter.
Source: SEC Filings & Cliffside Research
Travelzoo has often explained away the issue of declining net member adds by claiming a focus on higher quality member adds. We don't know how it defines higher quality members. We're only able to analyze the results, and the results tell a different story. As it has spent more to acquire fewer but "higher quality" new members, revenue per member has continually declined. The chart below compares revenue per member to the cost of adding net new "higher quality" members. It is very clear that despite increasing spend on higher quality new members, revenue per member continues to decline. Simply put, the strategy is not working.
Source: SEC Filings & Cliffside Research
In the most recent quarter, cost per net new member add was $10.28 and revenue per member was $4.77. This means that unless TZOO is able to improve its revenue per member figures, it will take about 2.15 years for TZOO just to cover the cost of acquiring the new member. It will be even longer for the customer to go from breakeven to profitable. In comparison, in the first quarter of 2010, at the far left of the chart, the time to cover the cost of a new member was about .58 years, or about 7 months.
In TZOO's first quarter 2015 call in the Q&A section Holger Bartel was asked about member acquisitions and he states that it takes about two quarters for these more expensive, higher quality members to begin showing results in revenue. A year and a half later, the results still haven't arrived. What gives? We suspect that the quality of the vast majority of the 28.9mil subscribers is far lower than the recently acquired members. That would explain why revenue isn't improving despite TZOO's efforts. Unfortunately, this likely implies many years of investment, as it would have to churn out a large percentage of its member base before revenue per member improves meaningfully. In our opinion, there's no doubt that this is a dying business.
Negative Member ROI Trends:
Based on the above, we began considering what TZOO's ROI trend might look like for new member acquisitions. TZOO is very protective of its user metrics. It provides no information regarding ROI on its investment in new members or member churn rates. On several earnings calls, analysts have asked for this type of information and management always says maybe it'll have it next time, but the next time it never does. History has taught us that any time a company doesn't want to provide investors information, it's probably not a good thing. Less data is never better. So we tried to see if we could back into some of the data, it doesn't want to provide by further exploring the data that it does provide and we found some interesting points.
First, the company appears to have about a 10% average member churn rate over the past several years. That means that each year about 10% of its members leave. Currently it has about 29mil members, so this year we expect it to lose about 2.9mil members. To keep things simple, let's just call it 3mil. That means that to add a net 1mil members to the user base to reach 30mil members, it has to add 4mil new members. Another way to look at this is to say for every four new members it acquires, it loses three (approximately). This is the reason net new member costs are so high. To acquire one net new member it really has to acquire four. Unless it can reduce churn and/or reduce member acquisition costs, this equation only gets worse as the user base grows. That means it likely will need to continue to increase member acquisition costs going forward just to keep the member base where it is.
Regarding member ROI what we found is truly shocking. TZOO provides revenue per member and it calculates it by annualizing quarterly revenue and dividing it by members at the beginning of the year. We decided to do the same thing but instead using Non-GAAP net income as provided by the company. That gave us Non-GAPP net income per member by quarter and we calculated that back to 2010. We calculated an ROI based on cost of a new member as provided by the company. TZOO doesn't provide the average life of a member, so for this we had to make an educated guess. Since the churn is 10%, over 10 years, it will basically have replaced all of its members. Based on this, it seems fair to assume the average life of a member is about five years. We feel this is likely generous and if anything it is probably lower. Then we multiplied Non-GAAP net income per member by five years to find the lifetime Non-GAAP net income value per member. From there, it was easy to back out the acquisition cost per new member to get to an estimated member ROI.
The results in the chart below show that TZOO's member ROI is likely trending negative and has been since Q3 2014. We believe this largely explains the acquisition of the APAC division in Q3 2015 as the company is essentially trying to pull out of a nosedive. What the chart indicates is that the company is currently spending more on acquiring new members than it can ever reasonably expect to make on them over five years. Since we believe the average life of a member is probably less than five years, the data could actually be considerably worse than our estimates. To put it simply, it is investing in new members for which we expect a NEGATIVE RETURN on its investment!!!
Source: SEC Filings & Cliffside Research
The recent improvement in the past two quarters is simply the result of staff cuts. We do not see this as a long-term solution to its decline. Two years of investment in "higher quality" members is not coming through in results as revenue per member continues to reach new lows.
You Can't Cut Your Way To Growth:
If you work at TZOO today, you're likely in fear of losing your job and/or looking for another one. Since Ralph Bartel's brother Holger Bartel was reinserted first as Chairman and then as CEO in October 2015, it's been open season on TZOO employees. About 20% of the workforce has been let go and we suspect there's likely more on the way. Cutting the workforce makes up the vast majority of its financial improvement and that has led to a rally in the stock of about 60% off its lows.
While there may still be some meat left on the bone, we feel the workforce improvement is now mostly baked into the stock. Certainly, cleaning house is a short-term positive for the company and shareholders, but at some point in the next couple of quarters, we feel it is going to need to show it can actually grow revenue for the stock to continue higher. Attempting to squeeze increased production out of fewer employees may prove to be difficult and ultimately a major mistake. TZOO is a very small company in comparison to peers. The fact that it cannot seem to grow and the only way to improve financial results is to cut employees is a very negative sign for its long-term survivability. As they say, when it comes to business if you're not growing, you're dying.
Source: SEC Filings & Cliffside Research
Model Crumbling Under Intense Competition:
How competitive is the travel and local deals business? Not even Jeff Bezos was able to successfully compete. Amazon decided it'd rather stick to easy targets like Wal-Mart (NYSE:WMT), Netflix (NASDAQ:NFLX) and Apple (NASDAQ:AAPL) rather than compete in TZOO's industry. In April of 2015, Amazon rolled out a local hotel booking product called Amazon Destinations. The idea was to offer "weekend getaway" destinations similar to TZOO, GRPN, Living Social and others "getaway" products. Less than seven months after launch, the division was shutdown with little explanation.
On the other hand, Google is increasingly looking to integrate travel into its platform. This makes sense because it can access personal itineraries from Gmail and integrate that information with Search and Maps. These features were just introduced to the new Google Trips app. While Google Trips currently does not include booking capability, it keeps the traveler engaged with Google's mobile platform by attempting to provide a seamless travel experience.
Google has also recently launched Google Destinations, a trip planning search feature complete with flight and hotel prices. Google rolled out the Destinations feature on mobile in March and has just released it on desktop this month. These are the kind of changes that could completely destroy TZOO's advertising business, which represents the vast majority of its revenue. No wonder it is diversifying away from advertising. Additionally, it is largely assumed that these entries into travel are the beginning of a move by Google to directly compete with OTAs for bookings.
In light of the above, we believe TZOO is experiencing intense competition on nearly every aspect of its current business. It offers nothing unique and is an extremely small player that is only getting smaller. We note that its hotel booking platform has many listings, if not most listings, offered in partnership with Travelscape LLC, a division of EXPE. This makes TZOO nothing more than an added middleman looking for a cut of the pie.
Its Business Is Dying:
Why is TZOO taking a huge risk attempting to transition its business into a highly competitive category dominated by giants? One word: mobile.
As Internet traffic has rapidly transitioned from desktop to mobile advertising rates have come under pressure. This is not good for companies like TZOO who rely on the majority of its revenue from Internet advertising. TZOO has said in its recent 10-K that the switch to mobile is hurting its business because advertisers are not willing to pay the same rates for tiny mobile screens. Mobile doesn't convert as well as desktop. This is a major problem for TZOO's business model and puts it in an extremely precarious situation. While the local and search businesses are struggling, its bread & butter advertising business is also struggling. Additionally, as a very small player in the space, it is only getting smaller as traffic and ad dollars consolidate to larger advertising platforms. It is becoming increasingly irrelevant to both consumers and advertisers over time. Simply put, this is a dying business!
So what does a dying business do when it's been forced into a corner? In TZOO's case, it has decided to enter the extremely competitive low margin cut-throat hotel bookings category hoping to slow the bleed. The fact that it has no experience or technological edge in the category doesn't factor into the decision to enter the market for one simple reason; it has no choice. It has been backed into a corner by the move to mobile and competition. In our opinion, it simply doesn't know what else to do. Now it is left with convincing its user base to use it when booking planned travel.
On the surface that might not sound like much of a stretch but we believe it is. The competition in the hotel bookings space is so intense, the competitors are so much larger and competing technology is so much better and well established that we feel this will be an extremely difficult market for TZOO to meaningfully penetrate. How much larger is the competition? In 2015, EXPE had sales of $6.7bil and PCLN had sales of $9.2bil. It's estimated that the 2016 gross worldwide travel bookings market is $1.4 trillion and growing yet somehow tiny TZOO can't find growth with a hotel booking platform that's taken it over two years to roll out and counting.
Entry into hotel bookings also makes TZOO a competitor to some of its much larger advertising customers. Lastly, we believe that like the local getaways business, which cannibalized its advertising business, the hotel bookings business will also cannibalize its revenue. The takeaway here is that the hotel bookings business should not be looked at as a source of revenue growth. The company alluded to this point on its recent earnings call in what we feel was a very telling explanation of how it sees the hotel bookings business
In regards to hotel bookings business…
Curious about so what it is today, maybe how you think that will look maybe exiting the year? And then maybe a couple years out kind of this going to sort of drastically kind of change the kind of composition of your North American travel revenues over the next few years, or is it going to kind of just be sort of a complement to kind of the core business?
CEO Holger Bartel then downplays the hotel bookings opportunity:
I mean hotels is only part of our business…so hotel is only a part of our revenues and then again commissions on hotels are again just a part of hotel. So just keep that in mind.
CFO Glen Ceremony follows up stating they are reacting to mobile and implies hotel bookings will cannibalize existing business:
Not a not a significant portion right now and I wouldn't expect it to be dramatically larger by the end of the year as you remember. There are a few reasons why we got into this business; one was just those trends on mobile, we wanted a solution that we could give our members a good experience on the hotel deals that we represent. And one thing, nothing's changed, we're still presenting really amazing hotel deals. It's just the way we're presenting that is different and the way we're monetizing that is changing. And there is - I would say a gradual shift from our advertising and the voucher-based hotel products to this hotel platform.
When a company says it is shifting" its revenue, it is cannibalizing revenue.
Hotel Bookings Are Not The Answer:
EXPE and PCLN have been consolidating the industry for the past several years and now dominate travel bookings. Meanwhile, TZOO has been hung out to dry. For example, Expedia has purchased Hotwire, Travelocity, Orbitz, Trivago and HomeAway. Priceline has purchased Kayak, Booking.com, Hotel Ninjas, Rocketmiles, OpenTable and others. Many of the companies purchased were formed long after TZOO. Why has TZOO been continuously passed over?
For one, competitors have continued to innovate and rapidly grow revenue, even smaller competitors that had a far later start than TZOO. From a technology perspective, competitors are years ahead of anything TZOO has to offer. TZOO on the other hand has taken a reactionary approach, only investing in the business model and changing directions when threatened.
As if the market for hotel booking wasn't already competitive enough, customer review and metasearch company TripAdvisor entered hotel booking in the US in 2014. Its product, which is called Instant Booking, just fully rolled out globally in the 2nd quarter of this year. This also appears to be a reactionary move as it has also felt a negative impact from the move to mobile. Like TZOO, it mainly relies on Internet advertising revenue to drive its business.
Neither TZOO nor TRIP was the first advertising-based travel business to attempt a transition to hotel booking. That title belongs to Kayak. Kayak attempted to enter hotel booking in 2004. Kayak co-founder and CEO Stephen Hafner thinks TripAdvisor will ultimately regret going the hotel bookings route and eventually get out, like it did. So far, TRIP has had a rough go of it in instant bookings. A key metric for TRIP, revenue per hotel shopper was down 19% in Q2 driven by difficulties in transitioning to Instant Booking and mobile trends. TRIP revenue in the quarter was $391mil compared to TZOO at $34mil, or more than 10x TZOO revenue. If TRIP is having a difficult time entering hotel booking and Kayak gave up on it, we believe the far smaller TZOO will find it much more difficult.
TZOO Provides No Unique Advantage:
As hotel and travel booking has essentially become a duopoly in the past few years, hoteliers have become concerned about the leverage EXPE and PCLN hold over them. Increasingly, they are seeking to protect their room inventory by encouraging bookings on their own websites. TZOO argues it is another option for hoteliers and can push consumers directly to the hotel's website. TZOO feels this gives it an advantage over competitors. However, we've found that EXPE & PCLN are addressing these issues.
For example, EXPE has expanded its business in advertising with its Expedia Media Solutions division. We see this as a major threat to TZOO's advertising business. In July of 2015, Expedia Media Solutions launched TravelAds Direct. This is in direct response to the trend by hotels to encourage bookings on their own site instead of with the OTA. With TravelAds Direct, hotels can now advertise on Expedia sites and when the link to the listing is clicked, it takes the customer to a new tab on the hotel's own site.
According to Matthew Reichek, senior director of product and analytics for EXPE, "a supplier-direct product like that would have been unthinkable for Expedia three years ago." While TZOO is coming after hotel booking dollars with its new offering, EXPE is coming after TZOO's advertising dollars. We believe TZOO will badly lose this battle.
This article discusses in great detail EXPE's move into advertising and based on what's described it appears light years ahead of anything TZOO is currently focused on. Additionally, this small internal unit formed in 2007 is already over $200mil in revenue and growing 20% per year. TZOO, formed in 1998 closed out 2015 with $142mil in revenue and declining. In our opinion, TZOO brings nothing to the table that Expedia and Priceline can't do better on their own.
This issue also highlights a major point we made in our August initiation on digital advertising company Everyday Health (NYSE:EVDY). Ad budgets go where Internet traffic goes. Within travel, PCLN and EXPE have consolidated traffic through a combination of growth and acquisition but they are not the only places to advertise travel. Increasingly, the largest platforms like Google and Facebook (NASDAQ:FB) are consolidating traffic while smaller platforms suffer. These are well-established trends that are long term in nature and not likely to change. As recent as 2007, 50% of consumer Internet traffic came from several thousand websites, today over half the North American traffic comes from only 35 websites. Traffic to TZOO websites peaked in 2011 with 13.8mil unique visitors per month and has been declining ever since. 2011 was also the last year TZOO provided page views.
Source: SEC Filings
In the meantime, while TZOO is working out the kinks on its basic hotel booking platform where it competes with industry giants, the competition is leapfrogging it by looking to the future. In a recent interview, Kayak CEO Steve Hafner said they are investing in "a lot of artificial intelligence" and "services that help younger generations connect with us." For example, it has a Facebook Messenger chat bot and interaction with Amazon's Alexa service where you can say things like 'Hey Kayak, where can I go this weekend for $300?' That sounds an awful lot like TZOO's turf to us. A few years from now, we don't think TZOO will be able to compete with this kind of technology. It simply doesn't have the technological experience, resources or scale to operate effectively in that kind of environment.
TZOO Is Complacent and Lacks Innovation:
TZOO's entry into the "local" category is a perfect example of its reactionary approach to competition. GRPN was formed in 2009 creating a new, innovative local deals and getaways business model. We believe TZOO immediately recognized the threat of this model to its business. It began competing in local deals in mid-2010. TZOO had about a 10-year head start on Groupon. How was it caught off guard? TZOO could have buttoned up the local deals category for itself years ago if it was forward thinking and innovative, but it let competitors slip in because it was complacent. So instead it was forced to play catch-up with the launch of local deals after Groupon had already leapfrogged it.
Initially, local deals were a big growth driver for TZOO and it led to its best year ever in terms of earnings in 2011. In that year, it also launched local "getaways." Local getaways compete with Groupon's and Living Social's getaway travel offer. Initially, getaways also helped drive revenue but over time, it became clear that it was actually cannibalizing its much higher-margin advertising-based travel business based on its email list. The space was and remains extremely competitive and as we've discussed, changing consumer purchase behavior has led to weakening results. TZOO's revenue began rolling over in 2013 while GRPN and others also continue to struggle.
Groupon remains a major competitive threat to TZOO. 120mil people worldwide have downloaded Groupon's app. In comparison, TZOO has had just over 5mil mobile app downloads. In 2015, Groupon had revenue of $3.1bil compared to $142mil for TZOO. At the time of its IPO in 2011, Groupon had 1,000 deals available worldwide. Now it has 650,000 deals worldwide. TZOO has closer to 1,000. Groupon intends to significantly increase marketing spend to drive customer growth according to its 2015 10-K.
We're not arguing that Groupon's uber-aggressive market share at any cost approach has been the path that TZOO should follow. Our argument is that Groupon and TZOO are on opposite ends of the extreme. Groupon formed in 2009 now has revenue of $3.1bil. TZOO formed in 1998 is struggling to stay above $130mil. TZOO's extremely cautious, reactionary approach has led to years of underperformance for shareholders. We believe this is the result of the shareholder structure of the company where one person, the founder, holds a controlling 50+% of the stock.
The above point illustrates a concern with TZOO. They are followers not leaders. When TZOO was formed in 1998, it was smart to be cautious and grow slow at first, but as it matured it should have become more aggressive to keep up with competitors that were gobbling up the market. As a small cap company, it can no longer afford to be followers with lagging technology that's consistently late to new markets. Unfortunately for TZOO shareholders, we believe it's already too late.
TZOO Isn't Shareholder Friendly:
We feel the company largely has been run as the personal piggy bank of founder and current Chief Talent Officer Ralph Bartel. Ralph Bartel currently owns 53% of TZOO. As a result, your vote as a stockholder doesn't count. Ralph Bartel can choose to do whatever he wishes with TZOO and there is nothing you can do about it. This has led to some interesting decisions by the board.
For example, in November 2009, TZOO's board approved the sale of its Asia-Pacific (NASDAQ:APAC) division to Azzurro Capital for $3.6mil. Azzurro Capital is 100% owned by TZOO founder, former Chairman and majority shareholder Ralph Bartel. Then last year, only six years after selling the business, TZOO bought the APAC division back from Azzurro Capital for $22.6mil. TZOO also made holders of APAC debt whole and the holder of debt for the APAC division was…you guessed it, Azzurro Capital. TZOO paid $3.4mil including interest to pay back loans made by Azzurro Capital (Mr. Bartel) to the Asia Pacific business. If we include the debt payments the acquisition price paid to Mr. Bartel was $26mil.
In November 2014, Azzurro provided a loan to Asia Pacific of $1.0 million with a stated interest rate of 8%. There were $1.0 million loans and $5,000 accrued interest due to Azzurro as of December 31, 2014. From January 1, 2015 to August 20, 2015, Azzurro provided loans to the Asia Pacific amounting to $2.2 million with a stated interest rate of 10%. In September 2015, the Company paid the due and outstanding principal loan amount of $3.3 million and accrued interest of $128,000.
~TZOO 10-K 2015
For most public companies, this kind of activity would raise serious eyebrows. Not for TZOO. Investors seem to have largely ignored the issue. A few travel news blogs have attempted to spin it as a positive for the company. The general consensus has been that the APAC division, which was TZOO's smallest and only started in 2007 was losing money. So Ralph Bartel bought the division to get the losses off TZOO's books during this growth phase. In the meantime, TZOO retained the option to buy the company back anytime between 2011-2020. During this period, Mr. Bartel could grow the APAC business and fund the losses to drive growth himself. Once the business was cash-flowing positively, he could sell it back to TZOO. It's been spun as a win-win for TZOO shareholders, which, of course, also largely benefits Mr. Bartel.
There's a problem with this theory. The APAC business is still not cash-flowing positively and the number of APAC "members" peaked in 2011-12. Members were still in decline when TZOO purchased APAC. Revenues have also declined from $12mil in 2013 to $10.7mil as of 2015. Regarding the acquisition, former CEO Chris Loughlin was quoted as stating that "the audience is over 3 million members and we are clearly past the start-up phase." We would add that the division is not only past the "start-up" phase but has quickly moved to the "decline" phase. Returning the division to growth will likely require a substantial investment, an investment that TZOO shareholders were supposedly avoiding by selling the division in the first place.
Our theory is that when the business was losing money in the 2009 recession, it was easy to sell it cheap, hence the $3.6mil price tag. Since that time the business has grown from about $2mil in revenue in 2009 to over $10mil, albeit now with stalled growth. APAC is still not cash flow positive, yet the company justified paying $22.6mil (plus another $3.4mil in debt repayment to Azzurro) to reacquire the money-losing operation.
Our first point should be pretty obvious. Who made money on this deal? Ralph Bartel. While the cash drain from the APAC business was being held off TZOO books, the company was able to post profitable growth in its North American and European divisions. Coupled with a short squeeze, the increased profit led to a large gain in the stock, eventually breaching the $100 per share mark.
During this period of extreme valuation beginning in 2011 when the stock at times was valued over 70x peak EPS, Bartel began selling TZOO stock. From April 2011 to February 2013, he sold 3.7mil shares for gross proceeds worth $210,994,952. We're guessing the proceeds from these sales largely offset any investments in the APAC division by a substantial degree.
Post these sales, Mr. Bartel still remains the majority shareholder of TZOO with 7.4mil shares or 53% of shares outstanding. The entire market cap of TZOO is $180mil dollars. Sales of TZOO stock have netted Mr. Bartel total gross proceeds over $395mil, more than 2x the entire market cap of TZOO. It's possible he also made a nice gain on the sale of the APAC division back to TZOO, so that's a win-win…for Bartel.
If you were a long-term shareholder over this period you would have seen the stock hit over $100 and then promptly drop into the $30s in 2012. Eventually, TZOO meandered its way down into the $8s. The move was triggered by several developments, not least of which was the fact that earnings peaked in 2011 at $1.42 per share. In 2013, a revenue peak followed and TZOO has been dying a slow death ever since.
Zika Is A Worldwide Threat and It's Getting Nasty:
2016 was the year we were introduced to the Zika virus. Thus far, the media spin on Zika has focused on its impact in the Caribbean, Central America, South America and Florida. It has also been categorized as a disease that the general populous shouldn't worry much about unless you're a female who's looking to get pregnant. However, mainstream media has largely ignored recent discoveries about the disease and it's beginning to spread to other tourism-heavy countries throughout the world. While the short-term impact to tourism has been largely downplayed, we believe over the long term, it has the potential to make certain regions of the world virtually off-limits for tourism. The impact to travel and tourism is further exacerbated by the fact that regions affected tend to be warm, tropical climates best suited for vacations.
We found an article in the Orlando Sentinel with quotes from Seth Forman, general manager of destinations at TZOO. In regards to Zika, Mr. Forman claims that although travelers have concern and anxiety regarding Zika, they are still committed to traveling to affected destinations like Florida. According to TZOO's survey, in February, 30% of American Travelzoo users said it would be a factor in their travel decision. That figure increased to 40% last month. Forman also said that Zika hasn't impacted international travel decisions much. We believe that could change in a major way.
As we're exiting the mosquito season, Zika concerns in the US are moving to the back burner but in other parts of the world, Zika is just getting started. Recently, Asia and Africa have become areas of concern for a major Zika outbreak, and many of these countries are ill-prepared to handle an outbreak. Singapore, Malaysia and Thailand have all experienced recent outbreaks and other countries including India, China, the Philippines, Indonesia, Nigeria, Vietnam, Pakistan and Bangladesh all contain the humid tropical elements Zika mosquitoes typically thrive in. Singapore has confirmed at least 341 cases of Zika since August 27th and Thailand announced at least 200 infections with many more likely unreported. China, the UK, Australia, Taiwan, South Korea and the US have all recently issued travel warnings for Singapore.
While the outbreaks are of concern, if the infection only impacts expectant mothers then it likely won't meaningfully slow the travel industry. Increasingly, there is evidence that Zika may harm infected adults with long-term consequences. Unfortunately, when it comes to Zika, the best science can tell us for now is that they just don't know. At first, they said it was only transmitted by a mosquito bite, then they found it could possibly be transmitted via intercourse. Now there is speculation it could be transmitted by saliva, tears or other bodily fluids.
What we find most disturbing, and what we think would be a game changer for the travel industry, is that there is some evidence that Zika can have a neurological impact on full-grown adults. In one recent case, a woman exhibited damaged memory after contracting Zika. Some of the effects have been described as similar to Alzheimer's and Multiple Sclerosis. There's growing concern that Zika actually may slowly destroy the brain's stem cells, cells responsible for developing neurons critical for learning and memory and the long-term impact for those infected simply is an unknown. It is still early and the implications, if true, would extend far beyond TZOO, but the impact of Zika, in combination with terrorism concerns, present potentially major near-term hurdles for a small company already in decline.
Here's the deal: The more we've learned about the Zika virus, the nastier it is.
~William Schaffner, infectious-disease expert at Vanderbilt University
The Balance Sheet Isn't As Strong As It Looks:
One of the strengths of TZOO is its cash position of $27.6mil with no debt. We note that while this is strong, it's not as strong as it had been prior to the APAC acquisition. APAC remains a cash burn for the company and the acquisition drew down its cash balance by about $26mil. So the balance sheet strength has deteriorated. We also note that the majority of the cash, $16.2mil, is held outside the US. This cash is not accessible to US shareholders unless the cash is repatriated at the corporate tax rate of 35%. Tax affecting the cash held outside the US results in a meaningfully smaller cash balance of $21.9mil vs. the publicly reported $27.6mil.
Additionally, we discovered in TZOO's SEC filings that it has been under an IRS audit for the past few years regarding the sale of the APAC unit. The IRS has issued a Revenue Agent's Report (RAR) to TZOO concluding the company owes back taxes and federal penalties of $31mil excluding possible additional interest and state penalties. The IRS audit conclusion is based on its view that the APAC business that was sold to Ralph Bartel's Azzurro Capital had a significantly higher valuation then the proceeds the company received upon the sale. It appears that the IRS agrees with our assessment that the sale of the APAC division to Azzurro Capital doesn't pass the sniff test.
To date, TZOO has not taken a reserve for this amount. It plans to fight this decision and will take the IRS to court if necessary. Not only is this scenario a distraction for the company, which could impact operations, it also adds to expenses. If TZOO exhausts all appeal options and ultimately has to pay $31mil in back taxes, it will have more than depleted all its cash reserves if paid in full. We argue this puts TZOO in an extremely precarious situation given the company is struggling to stem the tide of declining revenue with no imminent signs of improvement on the horizon.
TZOO's earnings have improved in the past two quarters strictly due to staff reductions. We see no signs of a turn in revenue despite increased spend on member acquisitions that began in Q3 of 2014. The company has been rolling out a hotel bookings platform now for over two years and appears to still be having difficulty with the transition. We believe this is directly the result of the intensely competitive nature of the booking industry where it has little to no background or technological advantages. The transition to mobile is crushing its advertising revenue and increasingly as the company shrinks it is becoming less relevant.
Currently, it is entering the seasonally weakest time of the year. In the first half, it was able to improve earnings over 2015 solely on cost cuts. We anticipate the second half will be better than the second half of last year but not as strong as the first half of this year. We are modeling for 10c in EPS for the 3rd quarter followed by 6c in EPS for the fourth quarter consistent with seasonal trends. That brings full year EPS to 44c. With the stock around $13 per share, the company is currently trading at nearly 30x 2016 earnings. We believe this is extremely overvalued for a dying business in the early stages of the largest operational transition in its history.
In 2017, we're anticipating the company will continue to attempt further staff reductions but to a lesser degree as much excess will have been wrung out of the system. At the same time, we expect investment in APAC to ramp meaningfully, specifically for member acquisition. The company has alluded to this in its recent investor calls. It likely needs to invest further in the hotel booking platform as well. Declining revenue in its core North American business, which represents 63% of revenue, is likely to continue weighing heavily on its ability to maintain long-term profitability. With 2017 looking like a year of slack revenue with increasing costs driven by APAC, we're forecasting EPS to decline vs. 2016. We're currently modeling for 33c in EPS for 2017.
We believe this is the most dangerous time to be an investor in TZOO in its history. The business is in decline and the future of the company relies on making significant progress in the hotel bookings portion of its business. The stock has already made a major bounce purely on cost cuts so the risk now is to the downside on failure to execute a transition to revenue growth. For the several reasons mentioned above and based on management's own comments, the chances of successfully transitioning the business is very low in our opinion. Therefore, we feel a 20x multiple on 2017 earnings is more than generous. Our 12-month target price for TZOO is $6.60 per share representing downside of approximately 50%.
If TZOO is unable to reverse what we estimate is a negative ROI on new members, we question its survivability as a business entity. In this scenario, downside would be closer to zero.
The recent increase in TZOO shares has been driven by higher EPS for the past two quarters of 28c and represents a solid improvement over the 11c in the first half of last year. Unfortunately, the entire improvement has been based on cost cuts almost entirely from staff reductions. Fundamentals continue to worsen with revenue remaining in a long-term decline. The company is currently in the early phases of an attempt to transition the business increasingly away from advertising into hotel bookings. Hotel bookings are not an area where it has experience and as we've described, competition in the space is fierce. For two years now, it has tried to roll out the hotel platform but to-date has had little success. We believe its transition to hotel bookings will ultimately fail due to several reasons.
- Larger, better operators have tried in the past to transition to hotel bookings and failed (see Kayak)
- No technological advantage over competitors
- Little to no experience running a hotel booking operation
- Difficulty transitioning its user base to think of it as a place to book planned travel
- Increased competition resulting from consolidation and new entrants including TRIP, GOOGL and Airbnb
- A confused user base that doesn't understand subtle differences between getaway vouchers vs. hotel bookings vs. Top 20 vacation package offerings
The local deals (vouchers) part of its business continues to decline due to competitive pressure and a change in consumer habits from a "push" to "pull," or purchase at time of use, mentality. These pressures are unlikely to subside.
In search, the company appears willing to allow this portion of its business to die on the vine. It has substantially reduced investment in the division and as a result, traffic trends continue to decline for fly.com and SuperSearch. Again, competitive pressures appear to be the culprit for the decline. We see no reason for a reversal in this trend.
We do not believe TZOO has been able to achieve the "critical mass" in travel, local or search necessary for long-term survival. Despite the fact that the Internet advertising industry is consistently growing about 10% per year, TZOO's revenue has been in decline since 2013. Mobile is now approaching 50% of digital ad spend and over time, this is likely to grow. TZOO has found mobile difficult to monetize due to lower click-through and conversion rates on mobile vs. desktop. This trend will continue to negatively impact its business.
As one of the earliest adopters to Internet advertising, TZOO has had plenty of opportunity to capitalize on the shift to digital. For several years, it was able to ride the tailcoats of this shift but the days of easy growth are over. As technology has advanced, TZOO hasn't reinvested enough to stay ahead of the competition. Like Kodak or Sears (NASDAQ:SHLD), we believe that TZOO became too comfortable in its niche and hasn't stayed ahead of the curve. History is riddled with examples of companies that failed to anticipate a changing marketplace. In most cases, by the time, they figure it out and try to "play catch-up", it's too late. This accurately describes TZOO's current situation.
While members continue to grow, revenue per member is consistently down while cost per new member continues higher. Additionally, when accounting for churn the acquisition cost of new members is far higher than reported by the company. Long term, these trends are unsustainable. The company claims it is acquiring higher quality members to justify the cost but there is no evidence of this in the financials. We believe there is no reasonable basis to assume it can make money on the members it is now acquiring, resulting in a negative ROI. It is also being impacted by issues like terrorism and we feel Zika could present a bigger issue for TZOO than is currently assumed.
In our opinion, the company is not shareholder-friendly due to the fact that the founder owns over 50% of the company. This has led to a lack of innovation and questionable financial arrangements. There is no opportunity for shareholder activism to improve operations at TZOO.
Currently trading near 30x our 2016 EPS estimate, we believe the company is substantially overvalued. Based on our expectation for increasing costs on declining revenue, we expect EPS to decline to 33c in 2017. We have a $6.60 target on shares of TZOO and see 50% downside to the current share price over the next year.
Disclosure: I am/we are short TZOO.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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