The Internet has changed the fundamental operations of a multitude of industries. In general, the move online has been great for consumers, but bad for business.
For instance, consumers can now have books delivered to their doorstep for less money than they would have to pay to go to Barnes & Noble, Inc. (NYSE:BKS) to pick them up in person. This means consumers’ dollars go further than they did in the pre-Internet era, while businesses’ bottom lines are much smaller.
Of course, many companies have sprung up to take advantage of the move to the Internet. Perhaps no industry has been changed to a greater extent than the travel booking industry. Companies like Priceline.com Inc (NASDAQ:PCLN), Expedia Inc (NASDAQ:EXPE), and Orbitz Worldwide, Inc. (NYSE:OWW) have wiped out traditional travel agencies as consumers move their activity online.
Priceline.com Inc (NASDAQ:PCLN) and its peers have created enormous value for consumers and reaped huge profits as a result of their first-mover advantage and market segmentation. Priceline and Expedia Inc (NASDAQ:EXPE) have traditionally avoided direct competition because Expedia focuses on the U.S. market and Priceline on international markets. Orbitz has also traditionally been focused on the domestic market.
For most of the last decade, online travel booking agencies have been able to grow without significant competition from rival online companies, but the maturation and saturation of the market may be about to change that.
As growth in the U.S. market slows, Orbitz Worldwide, Inc. (NYSE:OWW) and Expedia Inc (NASDAQ:EXPE) are looking internationally for future growth opportunities. Last year, Expedia announced a partnership with China’s largest Internet firm and an Asian airline as part of the company’s push into Asia. Orbitz, too, has announced its intention to focus on overseas markets as domestic growth slows. This inevitably leads to greater competition between online travel companies, which means lower profitability.
Not all bad
Although it looks like competition between online travel agencies will become more intense over the coming decade, it is likely that the industry will continue to be dominated by just a handful of companies. This is because the quality of a company’s product is a function of the size of its network of airlines, hotels, car rentals, and other services that customers have come to expect. As a result of the scale already built up in the industry, it will be difficult for newcomers to unseat the current oligopoly.
In fact, Orbitz Worldwide, Inc. (NYSE:OWW) is having a hard enough time generating profits as it is. As the third-largest U.S.-headquartered company in the industry, it has far greater scale than any newcomer could hope to achieve in a few years. However, the company has yet to earn a GAAP profit, and free cash flow is only now starting to become significantly positive.
Despite the inevitable increase in competition, the future is not all that bad for Orbitz and its peers. This is because, despite the barriers to entry, little capital investment is required to build and maintain a travel network. Those companies that have already achieved scale will benefit from the huge cash flows that come as a result of low maintenance capital expenditures.
Priceline.com Inc (NASDAQ:PCLN) generates more than $1.7 billion in free cash flow each year, Expedia Inc (NASDAQ:EXPE)close to $1 billion, and Orbitz close to $150 million. Each company’s cash flows reflect the size of its network relative to its competitors.
Expedia and Orbitz Worldwide, Inc. (NYSE:OWW) trade at less than 10 times trailing free cash flow, while Priceline trades at more than 25 times trailing free cash flow. This disparity reflects Priceline’s huge advantage in the international markets, but Expedia’s valuation does not reflect its stronghold in the U.S. and its share-grabbing potential in Priceline.com Inc (NASDAQ:PCLN)’s markets.
Although competition between the firms will surely intensify, and margins will surely fall, oligopolistic competition will hardly destroy these companies’ cash machines. It is unclear as to how much growth is in Priceline.com Inc (NASDAQ:PCLN)’s future, but it is clear that Expedia Inc (NASDAQ:EXPE) and Orbitz Worldwide, Inc. (NYSE:OWW) will continue generating a large portion of their current free cash flow in future years. As a result, the latter two companies may be worth a closer look.
Brick-and-mortar travel agencies are toast, but online travel agencies could reap huge profits in the future if competition between the firms does not become too intense. These firms may not have durable competitive advantages, but barriers to entry will help ensure that their competition remains direct at each other rather than a disruptive newcomer.
Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends Priceline.com. The Motley Fool owns shares of Priceline.com.
The article Online Travel Booking: Great for Consumers, Bad for Business originally appeared on Fool.com.
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