How About a New Business Model for Priceline?

And how does that work?

Priceline matches these bids with discounted (but otherwise undisclosed) fares offered by travel suppliers and determines whether to accept the bid. This offers leisure travelers highly discounted fares and also helps suppliers sell excess capacity without affecting published retail prices.

Notably, hotel bookings make up over 90% of our $452 price estimate for Priceline's stock, while air ticket bookings constitute less than 3%. Compare this with Expedia, where hotel bookings and air ticket bookings contribute around 57% and 10% respectively to our $38.57 price estimate of Expedia's stock.

Priceline has a strong foothold in the high-margin hotel bookings segment outside the U.S., facilitated by the acquisition of Bookings.com (for European markets) and Agoda.com (for Asian markets). In a recent article, we discussed the threat posed to online travel agencies by air carrier websites, which are now expanding their offering beyond the traditional seating options in an effort to draw bookings from third-party distributors and cut distribution costs in the process. This doesn't create too much risk to Priceline's business in particular, given the low contribution of air ticket bookings to its stock value.

We do, however, see a window of opportunity for Priceline. What if Priceline were to offer hotel bookings on airlines' websites?

How Does an Online Travel Agency Business Work?

At any online travel agency, air ticket bookings serve to attract visitors and account for over two-thirds of total bookings. Comparatively, hotel bookings offer OTAs markedly higher revenue margins (revenue earned by OTA as a percentage of the size of booking) at around 25% (vs. around 4% for air ticket bookings). Car rentals and other services are often offered complimentary and bundled with air tickets and hotel stays to make the offer more attractive and draw booking volumes from competitors.

Why Online Travel Agencies Offer Air Ticket Bookings?

Online travel agencies offer air ticket bookings despite very low revenue margins since air ticket bookings attract the most visitors. As the number of airlines selling tickets directly on their own websites has grown, online travel agencies have been compelled to eliminate booking fees and charge rescheduling/cancellation fees at parity with those charged by the airlines themselves.

While this further restricts profit margins from air ticket bookings, online travel agencies drive revenues by cross-selling other travel services such as hotel room stays and destination services, and bundling these into holiday packages that generate high margins.

A Win-Win Solution to the Woes of Airlines and Online Travel Agencies

While the airlines might offer the best fares, they do not offer customized hotel options at the destination, which is where online travel agencies still hold an edge. If Priceline sponsors hotel bookings on airlines' websites, airlines would be able to offer more comprehensive options to leisure travelers and, consequently, attract more bookings. At the same time, Priceline would be able to offer hotel bookings to a wider audience and gain market share in the process.

The Upside for Priceline

We currently estimate that Priceline's share of hotel room bookings will rise from around 2% in 2010 to about 3% in the coming years. If Priceline were to partner with airlines, we could reasonably expect a sharper pace of growth. To illustrate Priceline's stock value sensitivity to this metric, we estimate that an increase to 4% over our forecast horizon (vs. our base case projection of 3%) would imply a substantial 29% upside to our $452 price estimate.

And even if this were to marginally cannibalize air ticket bookings at Priceline's own site, the partnership more than compensates for the difference as air ticket bookings only constitute 3% of Priceline's equity value by our estimates.

Drag the trend line in the chart above to see the affect of various hotel market share scenarios on Priceline's stock value.

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