Preview Travel's Bumpy Ride

Like the vacation that looked great in the magazine but turned out to include a rundown hotel and lousy food, investors in Preview Travel (PTVL) may be getting less than they expected.

The San Francisco-based online travel agency may be heading for a tough landing, say money managers who are short the stock. They point to increasing competition in the online travel industry that will slice Preview's margins and make profits hard to come by. Shorts say Preview's much-publicized -- and expensive -- deal to sell service through America Online (AOL) isn't paying off (a common refrain among shorts), and they raise questions about the company's accounting.

Preview's market capitalization, at $114 million, has already been clipped from nearly $500 million earlier this year. But shorts aren't covering their positions yet. In August, Preview was the 23rd most shorted small-cap stock, according to Rockbridge Research. And short interest has climbed 56% since April, to 981,452 shares in September, out of 11 million. (Short-sellers sell stock they don't own, hoping to buy it back later after its price has fallen. For a primer on shorting, click here.)

Preview Travel is the newest incarnation of Preview Media, a company founded in 1985 to create travel television and in-flight programming. By 1994, the company lost $5.4 million on sales of $9.6 million in that business. The following year it ventured online, and by May 1996 Preview Travel was booking reservations on the Net. The television business now accounts for just over one-third of Preview's revenue, with online revenue making up the balance.

Like lots of other Net businesses, Preview hasn't found profits online yet. In fact, the company's losses are widening. For the year ended Dec. 31, the company lost $10.2 million, or $1.06 per share, on revenues of $13.6 million. That compares with a loss of $5.6 million, or 65 cents a share, on sales of $12.4 million in 1996. The company will lose $1.63 per share in 1998, and its losses will continue through 2000, according to a First Call sampling of five analysts.

Even so, Preview's prospects enticed investors when the company went public last November. From their IPO price of 11 a share, Preview shares soon soared to 44 a share. They've now finished a roundtrip back down, closing Thursday at 11 3/4.

Despite the tumble, shorts feel Preview has further to fall. Competition is rising, especially from airline companies who are trying to attract frequent fliers to their Web sites. Carriers like American Airlines (AMR) and United Airlines (UAL) are expected to grab 62% of all airfare booked online by 2002, up from 48% in 1997, according to Jupiter Communications, a research firm in New York.

Airlines have also squeezed Preview and other online travel agencies on commissions, a big source of Preview's revenue. The commission Preview gets from carriers fell from 10% to 5% last year. And some experts say more cuts are likely. "The airlines have come to view the Internet as a new distribution system," says Laurie Berger, editor of Consumer Reports Travel Letter in San Francisco. "They will do everything to build and support this channel and that means finding ways to get customers to come to their Web site. I absolutely predict they will take more aggressive steps to minimize their costs in that area."

A money manager, with about $100 million under management, who is short the stock, raises concerns about Preview's business model. "Everyone bases the Internet model on certain margin assumptions," he says, adding that the commission cuts will put pressure on margins.

Then there's the company's contract with America Online. Preview has agreed to pay AOL $32 million over five years for the right to be the primary travel service provider on the AOL network and its Web site, AOL.com. Eric Von der Porton, a portfolio manager with Leeward Investments, a San Carlos, Calif.-based money management firm that is short Preview, estimates that Preview will generate $5 million in revenue from AOL in 1998. Preview executives say their agreement calls for flat payments over the life of the contract, or $6.4 million a year. Considering Preview's costs are about 50% of sales, according to the company's financial documents, it has a long way to go before it breaks even on that contract, Von der Porton says.

Preview will not provide estimates for AOL revenue. But Kenneth Pelowski, Preview's chief financial officer, says the contract is more valuable than the actual revenue it generates since it creates exposure, builds brand recognition and draws traffic to the site. That doesn't satisfy shorts like Von der Porton, who say the company should be able to assess what kind of return it's getting from its AOL investment, just as it would from any other investment.

Preview isn't making it easy for investors to figure out whether the AOL deal has been a good one. Preview said that it generated $3.6 million in revenue from AOL in 1997 but declines to breakout AOL revenue on a quarterly basis. The company says it only broke it out for its most recent annual report to comply with Securities and Exchange Commission requirements that call for companies to itemize revenue when they're more than 10% of the total.

More troubling, say the shorts, are inconsistencies in Preview's financial statements regarding payments made to AOL and Excite (XCIT), another portal that Preview has promised to pay $24 million over five years. In filings with the SEC, Preview has repeatedly changed its reported payments in identical periods to AOL and Excite.

"You either made a payment to someone, or you didn't," says one short seller. "And 40 days after the end of the year you either know what that payment is, or you don't."

Preview executives say there's nothing odd in the changing figures. "It's common practice for any company going through an SEC filing process to make amendments," Pelowski says.

Furthermore, Pelowski and Kenneth Orton, Preview's president and chief executive, say concerns about airline commission cuts are overblown. They point out that Preview has offset those commission cuts with other revenue streams. Advertising contributed 18% to the company's online sales in the second quarter this year, up from 7% last year. And commissions from car rentals, hotels and vacation packages increased to 19% of sales in the 1998 second quarter, compared with 10% last year. Volume efficiencies have reduced costs. Electronic ticketing helped the company drive down its cost to $8.50 per transaction from $10.70. But Pelowski adds that further cost reduction is unlikely over the next few quarters.

In fact, Orton told investors during a conference call in July that the company's costs will rise in the second half of this year as it makes a significant investment in customer service.

Still, Preview has its fans.

"Travel is so appropriate for the Internet, and Preview's heritage is in developing travel products," says Lauren Cooks Levitan, an analyst with BancBoston Robertson Stephens in San Francisco. Levitan rates Preview a buy. Her firm has performed underwriting services for the company.

And Preview has succeeded in creating brand awareness. As of August 1998 it had 2.8 million unique visitors, as tracked by Media Metrix in New York. That's more than the other top travel Web sites, Expedia, owned by Microsoft (MSFT), and Travelocity. The challenge is in turning those visitors into buyers.

"It might prove to be too monumental a task, but those concerns are in the stock already," says Lynda Calkin, a portfolio manager with Westwood Management in Dallas, which has $1.2 billion under management and owns some Preview shares.

Preview is aiming to fatten sales through several initiatives, including vacation packages and the launch of a travel store announced Monday that will sell luggage and accessories. Levitan's predictions show Preview generating $64 million in sales by 2000.

Ron Pernick, Preview's director of public relations, says that all the worry about turbulence in the online travel business is misguided. He says Preview's growing advertising revenue underscores that the company is ready for take-off. "We're a major media company in addition to a travel commerce company," Pernick says.

But skeptics take a different approach. "When they call themselves a media company, that tells me that the travel agency business isn't so great," Von der Porton says.

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