A new perspective on Flight Centre: Part 2

When a strong, cash generating business with significant market share stops growing rapidly – a description befitting Flight Centre's leisure travel business – then strategy should also change. The Boston Consulting Group matrix visually describes the appropriate strategy for businesses in this situation. They're 'cash cows' that should be 'milked', with the proceeds either returned to shareholders or invested in superior opportunities; investing further in the stalwart business is unlikely to provide adequate returns. Instead, the matrix suggests focusing on 'star' businesses – those with high market share and high growth potential – or 'question marks' that could potentially become 'stars'.

Flight Centre's management is unlikely to openly declare it's employing a milking strategy for its leisure division; it would be detrimental to staff relations, for one thing. But last issue we posed the question regardless. Dividends certainly haven't been on the rise, and management doesn't believe investing heavily to try and dominate the online leisure business would qualify as a superior opportunity. But large investments made in the corporate travel market have met with significant success. The corporate business certainly displays a number of attributes to excite a Bostonian consultant.

Explosive growth

There's been explosive growth in Flight Centre's corporate total transaction value (TTV) over the past five years. As published last issue, and reprinted in Table 1, we estimate that Flight Centre's corporate TTV has almost doubled in the four years to 30 June 2009 – despite overall international corporate travel spending collapsing in the last year of that period.

The corporate travel market serves a wildly diverse customer group. At the big end of town, companies such IBM, GE and BHP Billiton have annual travel budgets measured in hundreds of millions of dollars. These businesses tend to have internal corporate travel managers, or even departments, as part of their human resources function. They can negotiate bulk deals directly with airlines, hotels and car hire companies, though many outsource some or all of the process to the giant travel management companies (TMCs), such as American Express.

At the other end of the spectrum sit businesses like The Intelligent Investor, which buys a few handfuls of domestic flights and hotel room nights each year. Our approach to travel booking is best described as do it yourself, whether through an agent, on the phone or, most regularly, the Jetstar website.

For companies with annual travel expenses a little larger than ours, though, it often makes sense to outsource the travel booking function. Flexibility and choice is often a more important determinant than price when it comes to corporate trips, and outsourcing the travel booking to a specialist tends to deliver those attributes better than doing it yourself. And, once the company travel budget grows beyond a certain point, outsourcing can deliver cost benefits too, on the pricing of travel and particularly in administration cost savings.

As the corporate travel budget continues to grow, so do the services that the corporate travel company can offer – from 24-hour emergency assistance to systems that do everything from reporting mileage to analysing possibilities for reducing costs and even helping to locate wayward staff. TMCs offer much more than just a booking service.

The global market

Given the diversity of customers, it's not surprising that a wide array of companies service the industry. At the top sit the giant global TMCs, such as American Express and Carlson Wagonlit, while at the other end are single operators, performing a function more akin to the traditional travel agent.

Finding good data on the sector is a testing and often futile task. It's no surprise that the industry is secretive, given the billions of dollars involved and, in particular, the competitive bidding for larger customers in a process similar to the global advertising sector.

When Business Travel News puts together its annual survey and rankings of the industry, none of the bigger players voluntarily participate and the journal is forced to play guessing games. Having looked at the sector, Flight Centre's caginess in separating its results by division no longer seems out of place.

American Express is a listed company, though, and while the numbers are buried amongst its many operations, its corporate travel business is either number one or two in the world. American Express reported global corporate travel sales (the equivalent of TTV) of US$21bn in 2008, on which it achieved a revenue-to-TTV ratio of 7.8%. That margin is higher than we'd have expected, and is perhaps reflective of the company's unique assets.

The privately-owned, Paris-based Carlson Wagonlit is in a similar category, with 22,000 employees and TTV generated by wholly-owned operations and joint ventures amounting to US$28bn, according to its website.

Privately-owned Dutch company BCD Travel claims to be the third largest global TCM, with 13,000 employees and TTV of US$14bn. Meanwhile, UK-based Hogg Robinson claimed in its 2009 annual report to be 'one of only three globally-experienced travel management companies' (it excludes BCD from this list); it achieved revenue of £350m in 2009. Though we haven't seen a public declaration of its TTV, we can work backwards to an estimate of around £5bn, or more than US$7bn.

Despite the massive size of these players, the market is fragmented. Carlson Wagonlit has previously estimated that the big four have a combined market share of about 25%.

The up and comer

If not very next on the list in terms of TTV, Flight Centre's corporate division, headed by FCm Travel Solutions, is among the next few. It also has a claim on being the most global of the second tier players, with company-owned operations in Australia, UK, USA, Canada, New Zealand, South Africa, China, Hong Kong, India, Singapore and Dubai, and a presence in more than 50 other countries through licensing arrangements.

Flight Centre has had a corporate business for more than 15 years, but its importance took off dramatically with the rebranding to FCm Travel Solutions in mid-2004. Some of the growth has come through acquisitions, such as Bannockburn Travel Management in 2005/06 and Garber in 2006/07, but organic growth has also been very important.

The division is headed by Shannon O'Brien. We've been quite impressed with O'Brien, who was chief financial officer (CFO) of the Australian retail (leisure) business from 2001 to 2005, and then Flight Centre's CFO from 2005, before becoming acting chief executive (CEO) while Graham Turner took long service leave last year. His recent appointment to head of corporate travel perhaps says something about the importance of the division to the company's growth plans.

Customers range from small and medium enterprises (SMEs) right through to large business accounts. Various specialist sectors are covered by separate brands such as Campus Travel, which is focused on the academic sector, Stage and Screen Travel Services, which caters to film/TV and entertainment businesses, and event management company CiEvents. The bulk of the business, though, comes through FCm Travel Solutions.

Small and medium enterprise focus

Although servicing all levels of customer, Flight Centre's corporate business is strongly focused on the SME sector. While big players like Carlson Wagonlit might state that 80% of their clients spend less than £250,000 a year, this is illusory – the bulk of TTV and profits come from the largest 20% of accounts.

In contrast, Flight Centre's corporate growth seems to have mostly come from SMEs – at last year's annual meeting O'Brien, then acting CEO, referred to the SME market as the company's 'core strength' and the 'star performer'. We posit that it again deserved that tag in 2008/09, a matter we'll discuss shortly.

Flight Centre's corporate sales have grown much faster than the market as a whole. Corporate travel isn't a new invention, but Flight Centre seems to be offering a new approach that many SMEs are finding attractive. Working out why customers are attracted to the offering is where the analysis becomes a bit more interpretational, but a recent quote from Graham Turner offers a useful starting point:

'We have a particular and peculiar business model that we are very true to and I believe it works particularly well in non-commoditised product.'

The unique business model, explained thoroughly in the book Family village tribe – the story of Flight Centre Limited by Mandy Johnson, revolves around Turner's theories on evolutionary psychology, where working units are limited to small teams of seven or less.

Personalised approach

With discount travel and internet competition, Flight Centre's leisure business plays in an increasingly commoditised industry. By achieving significant growth, though, management is making a successful argument that the corporate travel market is 'non-commoditised'. The indications are that FCm is actually taking business away from providers who have tried to commoditise the process, the reverse of what's happening in leisure. It's likely that FCm is also growing the market, by convincing SMEs who previously took care of their own travel arrangements to consider outsourcing the process (we've heard of door-to-door approaches by Flight Centre sales staff to a few small CBD businesses). 

As in the boom decades of leisure growth in the 1980s and 1990s, Flight Centre's growth in corporate this decade stems from a model that is big at the buying end (economies of scale), yet small at the selling end (personalised service). Where other TMCs have opted to centralise many functions in order to achieve economies of scale, FCm has differed by pushing responsibility down the chain, closer to where the travel manager and customer meet. This seems a particularly canny move in the SME market.

In an interesting article at www.buyingbusinesstravel.com late last year, Bob Papworth surveys the UK TMC market in Does size matter? In the article, FCm touts its 'one-to-one business relationships at all levels', claiming that the personal touch of the Flight Centre model gives it both service and price advantages, particularly at the smaller end of the market.

In the same article, a Hogg Robinson employee claims that 80% of its business is 'very much with the large corporate market'. Flight Centre is focused on a different pond to the big four TMCs, and in that pond it's becoming one of the big fish.

Most of FCm's Business Development Managers (BDMs), sales staff to you and I, sit in corporate offices. But Flight Centre is also putting more corporate sales staff into retail shops to exploit SME opportunities where it makes sense, such as in capital city central business districts. We're not sure where such sales fall in the company's reports, but they do hold the potential to be an important part of the business. Local presence is an essential part of Flight Centre's strategy.

It's not leisure, this is business

The financials for corporate travel look quite different to the leisure business. As we explained last issue, and in greater detail in our 2005 special report Looking under Flight Centre's fuselage, for each dollar of TTV about 13 cents flows through as revenue to the company (in other words, a revenue-to-TTV ratio of about 13%). In leisure, the revenue-to-TTV ratio has almost certainly been rising lately.

Operating expenses consume about 85% of this revenue, with 11-15% left over as earnings before interest, tax and amortisation (EBITA). Although that wasn't last year's experience – the EBITA-to-revenue ratio tends to fall in tough economic environments.

The corporate travel industry, however, operates on a much lower revenue-to-TTV ratio than leisure travel, perhaps 4% or less for giant customers and 5-8% for medium and smaller customers. We estimate that Flight Centre's corporate business achieves revenue-to-TTV towards the top of that general experience, as a result of its internal wholesaling and SME focus.

While the revenue might be lower for each dollar of corporate TTV, it looks to be similarly profitable. It's difficult to pinpoint given the lack of disclosure, but evidence suggests that corporate operates at a significantly higher EBITA-to-revenue ratio than leisure travel.

So the corporate division generates less revenue for Flight Centre from each dollar its customers spend on travel, but it incurs less in operating costs to generate that revenue. This combination means it comes out with a broadly similar profit ratio.

Part of the reason the cost base is lower is because corporate sales staff are able to sell much more travel than their leisure equivalent, due to the size of their customers' wallets and also because they don't have to deal with fruitless enquiries very often. This point highlights a significant difference between leisure and corporate, and suggests the latter faces less threats from internet-based competition, so it's worth exploring.

High conversion rate

Sales staff in the leisure operation are expected to process a minimum average of 75 customer enquiries per month. Typically, the 'conversion rate' – the percentage of enquiries that translate into actual bookings – is about 30% (according to a May 2009 report by Bryan Johnson of J.P. Morgan, one of the highest quality pieces of broker research we've seen on this company). During the latest downturn, consultants had little trouble keeping up their customer enquiry levels. It was the conversion rate that dropped off, resulting in lower TTV for the company.

Flight Centre's corporate business deals with far fewer tyre kickers and price checkers. The conversion rate on enquiries in corporate travel is vastly higher, perhaps 80-90%. The 'to do' list for a corporate salesperson is pretty short; sign up new customers and make sure they're coming to you with enquiries. Because once you impress them with your service and pricing, they will continue to do business with you.

On this front, the company is making significant progress despite those efforts being hidden by a poor economy. Over the year to 30 June 2009, corporate travel TTV was down somewhat. Existing clients 'downtraded', spending significantly less in a pattern we've seen mirrored across the economy, particularly in the six months to April 2009. But the corporate division won many new accounts, partially offsetting this downtrading. The cut in customer spending is masking underlying growth in the business. When the economy recovers, corporate TTV should receive a big boost.

While the corporate business is almost as profitable per dollar of TTV as the traditional leisure business, it is more capital-intensive. Historically, Flight Centre required very little debt or shareholder capital. In the leisure business most customers pay Flight Centre weeks, or even months, before Flight Centre pays the travel provider. So the company has access to a constantly replenishing 'float' which it has used to fund growth and bring in more float.

Corporate customers are generally wiser to the time value of money and, as a result, that float is much smaller or even non-existent. Increasingly, then, Flight Centre will need to turn to banks or shareholders to fund its growth. The cutting of the interim dividend and culling of the final dividend is perhaps a reflection of this fact.

Last issue, we pondered whether the corporate travel business could be Flight Centre's saviour. Growing a new business to replace an ailing one is a risky strategy. But this experiment is well underway and the growth in TTV, until now at least, is clear. Furthermore, new business wins suggest that the division has a long way to grow. If the division keeps growing at anything like recent rates, then Flight Centre's total TTV can continue to grow, almost regardless of what happens in the leisure business.

Significant growth opportunities

The growth potential of the market is vast but hard to pinpoint. We estimate that more than half of corporate sales are to Australian customers, and it's the market where FCm would have its highest market share, by a long way. According to the J.P. Morgan research cited earlier, management claim a corporate market share in Australia of 14-15%, about half their estimate of their share of the leisure market.

Our belief is that the next five years will see very little growth in shop numbers in the leisure business, Flight Centre's historic rocket fuel, but significant growth in corporate employees. And corporate travel will go from 40% of TTV today to 50% and beyond.

Last issue, we explained that the threats to Flight Centre's leisure business are proving much greater than we anticipated at the time of our 2005 special report. Back then, though, the corporate business was barely on our radar, and from a standing start it's grown to the point where corporate travel TTV is now greater than what the entire company achieved in 2002.

With one division on the wane, and another growing rapidly, valuing Flight Centre is a tricky act. Any valuation is loaded with assumptions but it's an essential part of the investing process to estimate the risks and potential rewards from holding the stock.

Next issue, in the third and final instalment of this series, we'll piece it all together and see how Flight Centre shareholders might fare under various scenarios. We'll provide our best guess estimates for TTV, revenue, EBITA, net profit, earnings per share and dividends for the next five years. And we'll also suggest some milestones to measure the progress of the business and our recommendation. HOLD.

Note: Everything we've learnt suggests Flight Centre has found a decent business moat in corporate travel. But the cagey nature of the industry means we still have plenty to learn from further interactions with customers, employees and competitors to FCm – which is why we've set up a special Bristlemouth post. We'd particularly love to see any comments industry insiders have to share. Feel free to speak anonymously, but if you're connected to the industry please let us know in roughly what capacity.