An online travel hypothetical

PORTFOLIO POINT: While being the smaller of the two, online airline booking group Webjet is now trading at a premium to its hotel bookings rival Wotif. It could book in a takeover play.

In the spirit of pure speculation, the current circumstances could, in theory, be conducive to a smaller up-start among the key online travel plays taking out its larger peer.

Wotif (WTF) is the dominant player when it comes to online hotel bookings in Australia, while Webjet (WEB) is the leader in online flights. WTF sells 1.5 times WEB’s bookings (Total Transaction Value or TTV), and its commission structure generates significantly more net revenue than WEB's booking fee model does. Thus WTF's net profit and market cap are 4.2 times and 2.6 times WEB's.

Historically WTF has been considered by the market to be the higher-quality business as its market share lead is greater in hotels than WEB's is in air, and because the commission structure of hotels means competitors are limited in their ability to win market share based on price (whereas WEB has always faced competition from low or zero-fee offerings—not that this has impeded its growth).

But sentiment has swung WEB's way over the past 12 months as it has demonstrated a stronger growth profile, while WTF has appeared trapped in a stagnant domestic travel market with the days of large market share gains behind it. WTF has battled to generate top-line growth, as the strong Australian dollar and competition among airline carriers encouraged holidaymakers to take their passports and head abroad.

Thus we arrive at a point where WEB is now priced at a significant premium to WTF – using consensus estimates, WTF is priced on an FY13f price to earnings ratio of 13.8 times, and an Enterprise Valie/EBITDA multiple of 8.2 times, while WEB is on 19.5 times and 13 times.

The relative multiples mean that if WTF shareholders were willing to accept WEB shares as consideration, WEB could afford a 30% premium over the prevailing WTF share price and still make the deal earnings accretive. And given the collective cash balances of the two companies, a cash sweetener could be thrown in.

In the past WTF’s departing chief Robbie Cooke has been clear-cut in his view that WTF would not be spending its cash on a bid for WEB. But it is now theoretically possible for the disinterested predator to become the prey.

The recent news that Cooke is departing WTF to take up the CEO role at Tatts Group means that WTF is without a leader – a circumstance which typically makes a merger and acquisition more likely.

WEB, meanwhile, last year transitioned from its founding chief executive, David Clarke (and now non-executive chairman) to current CEO, John Guscic, who has a strong background in the international hotel wholesaling and sales game. If Guscic was not embedded with WEB, one would imagine that he would be an appropriate candidate to take over from Cooke.

Mr Guscic was chief commercial officer of global hotel wholesaler GTA (a Travelport company until March 2011 when it was sold to Kuoni). And his chief operating officer, Shelly Beasley, enhances WEB’s credibility in hotels, having joined WEB in the second half of last year from her previous role as managing director of Travelport Pacific.

WEB could pay a paper-premium

I have run a “pro-forma” analysis based on consensus estimates for FY13 (alternatively I could use my own estimates, but the differences are not significant).

WEB could buy WTF at a 30% premium to the last close, including a 10% cash payment, and boost EPS by 14%.

The cash payment could be handled as a special franked dividend. WTF reported that it had $17.1 million in franking credits available for the subsequent financial year, which would result in about 50% franking of the $109 million dividend implied by my numbers.

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Beyond the numbers

I see significant strategic sense in placing WEB and WTF together.

WTF’s non-hotels business is relatively small ($61 million TTV and $7.3 million revenue in 2H12, compared to WEB’s total $399 million TTV and $29.5 million revenue). But there should be an opportunity to boost sales of WTF’s in-house inventory (23,539 properties it deals with directly) through WEB’s portals, complementing WEB’s current ramp-up of hotel sales aggregated from global wholesalers.

The combined group’s pro-forma FY12 TTV would have been $1.9 billion, of which hotels would have represented about 55%. This would be more in keeping with the global online travel agencies like Expedia, for which air travel represents only about 11% of its total sales.

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WEB appears to be more aggressive offshore, something WTF has struggled with, including the establishment by WEB of a business-to-business hotel aggregation platform in the Middle East that would expand WTF’s footprint).

At the end of the day, WTF founders Graeme Wood and Robert Brice hold all the cards, owning 21.7% and 16.1% of the company, respectively. I have no insight into whether they would want to see such a deal done.

I currently rate WEB a “Hold”.

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Hugh Robertson is executive director at Investorfirst Securities and is a shareholder in Webjet. hrobertson@investorfirst.com.au