It's starting to look like the online travel site business is getting overbooked.
Thomas Underwood Analyst, Legg Mason
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Last week, the much-anticipated launch of airline-owned travel Web site Orbitz debuted, and was promptly bogged down by technical glitches and delays. Orbitz is owned by AMR's ( AMR) American Airlines, UAL's ( UAL) United Airlines, Delta Air Lines ( DAL), Northwest Airlines ( NWAC) and Continental Airlines ( CAL). The Web site is part of the airlines' effort to increase the distribution of their inventory of seats on the Internet and compete head to head with Sabre Holdings'Travelocity.com ( TVLY) and Microsoft'sExpedia ( EXPE) Orbitz has sparked complaints from consumer groups, competitors and conventional travel agencies and drawn the scrutiny of regulators amid concerns that its airline owners will use the site to collude on pricing -- allegations Orbitz and the airline companies strenuously deny. We talked to Thomas Underwood, an analyst who covers online travel companies at Legg Mason, to see what changes, if any, Orbitz will bring about in the electronic travel booking industry, and what one should watch out for as a customer of and an investor in the industry. Legg Mason has done no investment banking for Travelocity or Expedia. TSC: Orbitz's debut was marked by what the company described as a larger-than-expected volume of calls and technical problems. This sounds not unlike the early turbulence of America Online's service, which attested to pent-up demand. Do you think Orbitz will succeed to the detriment of Travelocity and Expedia? Underwood: If you look at the volume that Travelocity is doing on a daily basis, they are on pace to do $3 billion to $3.6 billion in sales this year. The business that the current players of online travel are doing are well north of what Orbitz could do right now. TSC: What are the growth and revenue expectations for Orbitz out there? Underwood: Its ambition is that it will become profitable by 2003, and in terms of growth in travel booking, the company hasn't issued any projections because it's a private company. TSC: You sound confident that Travelocity and Expedia are ahead of the curve in comparison with Orbitz, and that they will continue to do well. Underwood: Yes. Both of these companies are cash flow positive, and booked more than $2 billion worth of travel last year. Orbitz has the potential to be a formidable competitor, and it is an interface for airline bookings with consumer-friendly features that differentiate the site from Travelocity and Expedia. With $100 million in marketing, Orbitz will most likely impact Travelocity and Expedia. TSC: What is the current market size and market share breakdown for online travel? Underwood: Last year, there was $7 billion worth of travel booked through online travel agents. The total market size for Internet travel booking was about $14 billion in 2000, which included online sales by airlines such as Delta and Northwest as well as hotel and car rental companies. In terms of airline tickets, Travelocity, Expedia and priceline.com ( PCLN) combined have three-quarters of the market, and Travelocity and Expedia alone have about two-thirds. TSC: How does Orbitz differentiate itself from other travel Web sites? Underwood: For the actual inventory that's on the site, Orbitz has access to Internet specials with restrictions from airlines, which are not available elsewhere. So Orbitz does likely have better fares. On the other hand, Expedia and Travelocity have negotiated deals with airlines themselves as well, and have fares that Orbitz does not have. Overall, I cannot find one site that has the lowest fare at all times. TSC: Among the established players, which business model do you like and which company do you prefer? Underwood: I cannot see any one of the three dominating. priceline has the most profitable business in terms of profit margin as percentage of travel value, and it also focuses on smaller niche than overall travel. Expedia has done a very good job of pursuing non-published fare and rate arrangements with airlines and hotel companies. They have been creative in terms of getting inventory. In terms of distribution, Travelocity has the largest distribution through its deals with Yahoo! and AOL, and initiatives for brand awareness. I think all three will be around for a very long time. And Orbitz also will be a viable player. But Orbitz will face the greatest challenge for some time to come, because it's the newest one around. Problems Orbitz experienced at the launch reflect what is to come. As Orbitz attempts to reach the scale necessary to reach profitability, it will experience the hiccups that companies like Travelocity had to deal with. TSC: Could you take a step back and look at Orbitz as something that addresses the ambitions and needs of the airline industry? What are important issues to keep in mind? Underwood: There is the question of whether it is legal for all the airlines to get together and determine distribution through a single entity. The airlines have emphasized that that is not their goal. They have said that they are looking for additional competition, and that Orbitz is just another channel. We will have to see whether that's the case or not. TSC: What is your gut feeling on this? Underwood: My gut feeling is that the airlines want to control distribution as much as possible. I mean, the airlines are not known for customer service. They rate about where the IRS does. If they expect an airlines-created entity to have a strong customer service focus, they should perhaps look in the mirror. If you go to Expedia right now, you will see that its site is far more robust than Orbitz, which even Orbitz would admit. You can purchase fares very quickly, with the help of mapping that shows where you are going. You have a good hotel section with ratings. Expedia has spent millions of dollars and a number of years developing that site. Currently, Orbitz does not compare favorably across a broad array of travel products. The cumulative advantage comes from years of being in business, tweaking customer service and technology. TSC: Airlines are not at all concerned with cannibalizing online booking on their own Web sites? Underwood: Airlines' own Web sites are primarily for brand loyal customers with frequent flyer miles who are also more profitable to the companies. The Web sites offer these customers specials through different search paths. A general online travel Web site serves a different function: Orbitz is for general distribution for airline companies' inventory and for leisure travelers, and makes the cost format more efficient. TSC: What trends should we watch out for both as investors and customers of these businesses? What investment opportunities do you see in the online travel industry? Underwood: As customers of the online travel reservations companies, two things one should be aware are service and value: In terms of service, when you need to call someone, can you get through? Are the answers to questions you may have on the site? The other is value: For relatively simple transactions such as flying to San Francisco and back, Internet travel is a better proposition than using off-line travel agencies. Rather have someone read the screen to you, you can do your own searches. Also, the capabilities of companies such as Expedia and Travelocity are more robust than those of many conventional travel agents today. When you look at online travel companies as businesses, relationships to suppliers are very important, meaning how the Travelocitys and pricelines of the world relate to the airlines and hotel companies. If Travelocity and Expedia add value in terms of travel distribution as I believe they do, then they should be able to do business quite profitably. If the airlines and hotel companies don't see that, then that indicates that a problem could arise. I would also look for improvement of the percentage of people who visit the site actually buying travel. We have seen steady improvement in this area from day one. Numbers are now up to the mid single digits; about 6% to 7% of those who come to the sites end up booking. I believe a lot of that is because of research people do prior to actual booking. My top pick is a smaller Internet travel company called CheapTickets ( CTIX). Legg Mason has done no investment banking for CheapTickets. If you want the best value on an airline ticket and call CheapTickets, you would probably get a better deal than you would with Travelocity or Expedia. Because any fare that shows up on Travelocity and Expedia are published fares that others can see, a fare that is only available through a call center is difficult for competitors to match. So airlines are more willing to give good deals to CheapTickets' call centers, which often have even better deals on their own Web site. I like this company also because of capable management and its track record of strong earnings. The company is due to earn 57 cents per share this year; their stock is $15, and they are putting in a new Web site that will have the functionality that Travelocity and Expedia have. They're relatively unknown on the East Coast, but they're about to launch an advertising campaign that I believe will be successful.