Shares of


reeled last week when the company said weak airline sales would cause it to miss fourth-quarter revenue goals. With the stock still trading for twice what it cost at the start of 2001 and at a steep earnings multiple, this putative dot-com success story can ill afford another misstep.

Shareholders might therefore be forgiven for wondering if the company set itself up for another fall by laying out what seems like an ambitious goal: revenue growth of 20% to 30% in 2002. For a variety of reasons, analysts say, the numbers are achievable, but not guaranteed.

"Travelocity's numbers are realistic," said Thomas Underwood, an analyst at Legg Mason. "But if leisure travel was to slow considerably this year, they would be very challenging."

Priced In

For the just-completed fourth quarter, lowered its revenue estimate by 9% to $68 million, citing capacity and fare reductions by airlines and continuing depressed traffic caused by the Sept. 11 attacks. The news knocked the shares down $3.05 to $24.39 on Friday, although at $24.15 on Tuesday they still trade at a forward price-to-earnings multiple of 36.

The drubbing might've been worse if the company hadn't tacked on the 2002 forecast. "We should benefit significantly as consumers shift towards online sources for travel purchases and as the tourism industry in general rebounds," said Terrell Jones, chief executive of Travelocity, in a statement.

Too optimistic? Air passenger traffic was down 20% in November, according to the Air Transport Association, and preliminary data show it was off 15% in December. Still, some analysts say a recovery is in the works. Glenn Engel, an airline analyst at Goldman Sachs, on Tuesday narrowed his fourth-quarter loss estimates by an average of 10% for most of the airlines, citing higher traffic.

Analysts say Travelocity is betting the terrorist attacks cut 2001 revenue enough that coaxing a 20% or 30% gain this year is possible, particularly if the trend in online sales resumes as memories of Sept. 11 fade. Even with the terrorist attacks, online travel spending totaled $20.4 billion in 2001, up from $18.2 billion in 2000, according to Jupiter Media Metrix.

Still, expectations vary on when airline capacity -- down 20% in December from a year ago -- will come back. "I'm not looking for a complete return to pre-attack capacity until mid-2003," said Helane Becker, an analyst at Buckingham Research. "Load factors are still below those that justify higher fares."

No Bargain

Cut-rate fares also hurt Travelocity's fourth-quarter revenues, as airlines resorted to steep discounts after Sept. 11 to fill seats. "When tickets sell at a discount, as they have over the past few months, it hits companies like Travelocity's gross margins," said Underwood. Because of the company's fixed commission percentage arrangement with the airlines, any ticket that sells for less than $200 eats into revenue.

Most of Travelocity's sales are classified as "transaction revenue," which is largely commissions on airline ticket sales. For tickets sold through its site, the company collects 5% of a fare, up to $10 per ticket. In the third quarter, transaction revenues accounted for $55.4 million, or 71%, of its $78.5 million in total sales, and a 15% to 20% estimated shortfall in such revenues led to the fourth-quarter warning.

On top of transaction revenues, advertising proceeds accounted for $14.6 million, or 18.6%, of the company's total revenue in the third quarter. Travelocity also took in $8.4 million, or 10.7%, of its total sales from what it defines as "other sources," which include delivery and handling charges for tickets.

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For 2001, revenue will be about $301.7 million, using Travelocity's revised fourth-quarter estimates. To meet the low end of its predicted range, the company would have to post revenue of about $360 million in 2002.

Bailey Dalton, an analyst at C.E. Unterberg Towbin, estimates that to achieve that, Travelocity's transaction growth would have to increase 13%, from an estimated 11.4 million transactions in 2001 to about 12.9 million in 2002.

Dalton assumes the amount of money the company makes per transaction will increase from $18 in 2001 to $20 in 2002 as the company improves its product mix. When the calculations are done, that means transaction revenues would climb 23%, from $206.4 million in '01 to $253 million in '02.

"They've probably left themselves enough room in that number," said Dalton, "particularly since travel spending continues to shift online." Dalton assumes 4% growth in the company's advertising revenue and 31% growth in its revenue from other sources.

The Markup

In the meantime, Dalton and others argue that Travelocity must move beyond its reliance on airline commissions as its main revenue stream to a merchant model, which


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has already done, whereby Travelocity could get wholesale rates from hotels and airlines and then mark them up.

The benefits of diversified revenue are evident in Expedia, whose stock sat tight at around $42 even as Travelocity's fell.

"Expedia is less reliant on airline ticket sales," said Jake Fuller, an analyst at Thomas Weisel Partners. "Travelocity explicitly said that the top line would be light because of airline tickets." According to Fuller, only 30% of Expedia's total revenue comes from sales of airline tickets.

Still, there is some question about why Travelocity faltered in the last two weeks of December, when other sources showed an improvement in air traffic over the holiday period. "I don't have a good answer," said Fuller. "They indicated it could be the result of lower capacity -- less seats available to sell."

In any case, Friday's announcement highlights the need for the company to reduce its dependence on airline tickets. "It's a commodity business, margins are low, and


another travel site appears to have a significant price advantage," said Fuller. "Travelocity has to shift into higher margin categories, which they're doing. It's just a question of what the product is going to look like."