This is a company which I have been watching for many months. I missed its low point in 2012 and have been waiting for a better entry to get in since. It possesses many of the characteristics that I like in a business model - (i) generates free cashflow, (ii) easy to understand business, (iii) strong barriers to entry and (iv) high ROEs. For many of us who uses travel agents, the business model should not be too difficult to wrap your head around.
TravelSky Technology is a Global Distribution System (GDS). What they essentially do is operate the booking back-office booking for travel agents, allowing agents to to check the available inventory of flights and hotel rooms on specific days and match them to the demands of the end consumer. They are plugged into the IT systems of hotels and airlines so that the data is updated live. Without GDSes, agents have no way of accessing and filtering the amount of data to find the right flight and hotel room for the customer. For their services, a GDS typically receives a commission from the airline/hotel for making a booking and shares that commission with the travel agent.
History
GDS is an old business model. They have been around for decades and were initially started by airlines to distribute tickets. Many of the GDS today still have airlines as parent entities. Ironically, decades after, airlines have failed to generate much profit and it is the GDS that captures most of the value in the supply chain for tourism travel. Globally, over years of M&A and consolidation, there are three major GDS -
(i) Sabre created by American Airlines,
(ii) Travelport, which is a conglomerate of multiple smaller GDSes including Galileo, Apollo and Worldspan.
(iii) Amadeus, which is created by an alliance between Air France, Lufthansa, Iberia Airlines and Scandinavian.
In recent years, GDSes have made some progress integrating downstream into the travel agency business, especially online travel agents. For example, Sabre owns Travelocity and Zuji, and Travelport is a significant shareholder on Orbitz Worldwide.
Competitive Landscape
Warren Buffett dislikes investing in airlines for very good reasons.
(i) There is little customer loyalty in air travel (corporate air travel booking do have some degree of loyalty).
(ii) Price competition is rampant in the industry. Air flights are becoming like commodities and it is very difficult to differentiate yourself from your peers. The only exception I am aware of is Singapore Airlines, which have build a franchise in service and the image of the Singaporean Girl.
(iii) Capacity is not removed from the system when one of the existing players goes bankrupted. The planes are usually sold off and resurfaces under another airline's wing. This is very important because general overcapacity of the industry is not a good environment to foster price discipline.
Although the cost of flying has decreased substantially over the years and the number of people flying for leisure holidays exploded, airlines still struggle to generate decent profits. To their credit, airlines have tried a variety of initiatives to promote customer loyalty but with poor results. They pioneered the frequent flyer loyalty point and premium membership model many decades ago, which is now copied by many other businesses. Now, airlines are trying very hard to make their pricing model opaque to discourage price comparison. For example, charging additional fees for extra leg room, more luggages weight, or food and services is a function of that. The end total cost of flying on that airline is not obvious. It used to be that the earlier you buy a ticket, the cheaper it is. Now, ticket prices fluctuate widely from time to time and most consumers can't make meaningful guesses about trends of air ticket prices. But still, with low cost carrier carriers entering markets and smarter ways of comparing prices (meta search travel sites such as Kayak.com. I personally use Skyscanner which is awesome.), airlines continue to suffer.
While GDS have been the main beneficiary of the growth in air travel over the year, that status is coming under threat. In America, the airlines have undergo sufficient consolidation such that they began to have some bargaining power over GDSes. Some airlines have resolved to cutting commissions to GDS/travel agents in order to raise their margins. Other airlines tried to remove GDSes out the picture entirely by persuading travel agents to plug in directly to their inventory management system. This way, airlines avoid paying two layers of commission. Another initiative which airlines have started to encourage consumers to book air tickets directly from their website. This way, they do not pay any commission at all. Would TravelSky Tech also come under a similar threat?
China Travel Industry
The Chinese travel industry resembles that of the US in the early days. There are a number of regional airlines, each with their own hub. However, unlike the US or Europe, TravelSky Tech is a monopoly in China. Concerns that further integration in Chinese airlines would threaten the fees that Travelsky Tech earns is less relevant here. Chinese airlines also depends very much on travel agencies for distribution. If you have travelled within China, you realize that the older generation buys their tickets, tour packages from brick-and-mortar travel agencies. The younger generation tend to prefer free and easy travel plans and purchases theirs accommodation and air tickets from online travel agents. Few people purchase their tickets/accommodation straight from the service providers' website. The main inconvenience here is that, it is too troublesome to surf site by site to compare prices and dates.
However, there has been political pressure from developed countries for the China government to deregulate the Chinese GDS market. This culminated in the opening of the booking for non-chinese airline tickets to foreign GDSes. What this means is that, foreign GDSes can now compete in the area of making booking of air tickets from foreign airlines tickets. This I believe is restricted to mostly international flights. Domestic flights are covered by domestic airlines and remains in the grip of TravelSky Tech. The Chinese government has a history of grooming domestic champions to compete with international peers. Thus far, they have been very cautious when it comes to liberalizing any sector or industry. The CNY is one good example, where they have experimented with partial liberalization in Hong Kong to test the results. I believe the same will occur here in the travel GDS industry. Completion liberalization is probably going to take quite some time, perhaps in the order of 5-7 years. The current opening of foreign airline ticket booking to international GDSes will not hurt TravelSky Technology too much. As of end 2012, TravelSky Technology processed 330 million bookings for Chinese commercial airlines, compared to 16 million on foreign and regional commercial airlines. The monopoly is largely intact.
To prepare for the internationalisation the business, TravelSky Tech has been working on acquiring a larger inventory of international hotel rooms and international air flights. This involves negotiating with hotels and airlines in other countries to list their inventory and plug in to TravelSky Tech's system. A quick way to do this is to simply to form alliances with international GDSes, which in this case the partner is Sabre. I see this as an arrangement which benefits TravelSky Tech more than Sabre. Sabre wishes to tap on the growing population of chinese consumers that are travelling for leisure. However, they have limited distribution and inventory in China. The partnership gives Sabre the inventory, but they still need time and resources to build out their distribution network with chinese travel agencies. TravelSky Tech however, has an pre-existing distribution channel and relationships with domestic travel agents. By accessing Sabre's inventory of offshore hotel rooms and airline line flights, TravelSky Tech can immediately offering international hotel and air flight bookings to its customer base. Why does Sabre do this then you might ask? Because travel in Europe and the US is a mature market and growth rates are low. In order to grow, Sabre has to gain access to emerging market consumer, which China is the largest.
TravelSky Tech has seen consistent top line and bottom line growth averaging mid-teens over the last five years. 2012 was a slow down for the company as growth of the Chinese economy moderated. As the Chinese economy continues to restructure from export driven to a consumption based economy, I expect revenue to grow at mid to high single digits. However, when the world and export recovers, I believe revenue growth can rebound to ~15%. Operating and net margins have been very stable for the business.
Historically, TravelSky Tech generates a decent amount of free cashflow. 2010 capex was abnormal for TravelSky Tech. That year, the company spent close to RMB2bn on land use right. That is not capex related to their business. Excluding that, FCF for 2010 comes up to about RMB1bn. For TravelSky Tech, the resource intensive part of the business is at the start, when it needs to construct its system and build relationships with travel agents, airlines and hotel operators. Once that has been done, it does not take a lot of capex to maintain or growth its business.
TravelSky Tech currently trades at a trailing PE of 10x. I believe this is a fairly cheap for a business model that enjoys a monopoly, stable margins and generates decent amounts of cash. It has about HKD$1.1 of net cash per share sitting on the balance. Ex-cash, TravelSky Tech trades at a trailing PE of 7.6x. While I believe it is cheap, I have yet to initiate a position. My estimate for fair value for this stock is 12-13x PE, which is HKD$6-6.50. It doe not not hit my investment benchmark of identifying and buying stocks trading 40% below their intrinsic value. I would continue to watch this stock for sure. What I would really love here is a fall in the stock price.
TravelSky Technology is a Global Distribution System (GDS). What they essentially do is operate the booking back-office booking for travel agents, allowing agents to to check the available inventory of flights and hotel rooms on specific days and match them to the demands of the end consumer. They are plugged into the IT systems of hotels and airlines so that the data is updated live. Without GDSes, agents have no way of accessing and filtering the amount of data to find the right flight and hotel room for the customer. For their services, a GDS typically receives a commission from the airline/hotel for making a booking and shares that commission with the travel agent.
History
GDS is an old business model. They have been around for decades and were initially started by airlines to distribute tickets. Many of the GDS today still have airlines as parent entities. Ironically, decades after, airlines have failed to generate much profit and it is the GDS that captures most of the value in the supply chain for tourism travel. Globally, over years of M&A and consolidation, there are three major GDS -
(i) Sabre created by American Airlines,
(ii) Travelport, which is a conglomerate of multiple smaller GDSes including Galileo, Apollo and Worldspan.
(iii) Amadeus, which is created by an alliance between Air France, Lufthansa, Iberia Airlines and Scandinavian.
In recent years, GDSes have made some progress integrating downstream into the travel agency business, especially online travel agents. For example, Sabre owns Travelocity and Zuji, and Travelport is a significant shareholder on Orbitz Worldwide.
Competitive Landscape
Warren Buffett dislikes investing in airlines for very good reasons.
(i) There is little customer loyalty in air travel (corporate air travel booking do have some degree of loyalty).
(ii) Price competition is rampant in the industry. Air flights are becoming like commodities and it is very difficult to differentiate yourself from your peers. The only exception I am aware of is Singapore Airlines, which have build a franchise in service and the image of the Singaporean Girl.
(iii) Capacity is not removed from the system when one of the existing players goes bankrupted. The planes are usually sold off and resurfaces under another airline's wing. This is very important because general overcapacity of the industry is not a good environment to foster price discipline.
Although the cost of flying has decreased substantially over the years and the number of people flying for leisure holidays exploded, airlines still struggle to generate decent profits. To their credit, airlines have tried a variety of initiatives to promote customer loyalty but with poor results. They pioneered the frequent flyer loyalty point and premium membership model many decades ago, which is now copied by many other businesses. Now, airlines are trying very hard to make their pricing model opaque to discourage price comparison. For example, charging additional fees for extra leg room, more luggages weight, or food and services is a function of that. The end total cost of flying on that airline is not obvious. It used to be that the earlier you buy a ticket, the cheaper it is. Now, ticket prices fluctuate widely from time to time and most consumers can't make meaningful guesses about trends of air ticket prices. But still, with low cost carrier carriers entering markets and smarter ways of comparing prices (meta search travel sites such as Kayak.com. I personally use Skyscanner which is awesome.), airlines continue to suffer.
While GDS have been the main beneficiary of the growth in air travel over the year, that status is coming under threat. In America, the airlines have undergo sufficient consolidation such that they began to have some bargaining power over GDSes. Some airlines have resolved to cutting commissions to GDS/travel agents in order to raise their margins. Other airlines tried to remove GDSes out the picture entirely by persuading travel agents to plug in directly to their inventory management system. This way, airlines avoid paying two layers of commission. Another initiative which airlines have started to encourage consumers to book air tickets directly from their website. This way, they do not pay any commission at all. Would TravelSky Tech also come under a similar threat?
China Travel Industry
The Chinese travel industry resembles that of the US in the early days. There are a number of regional airlines, each with their own hub. However, unlike the US or Europe, TravelSky Tech is a monopoly in China. Concerns that further integration in Chinese airlines would threaten the fees that Travelsky Tech earns is less relevant here. Chinese airlines also depends very much on travel agencies for distribution. If you have travelled within China, you realize that the older generation buys their tickets, tour packages from brick-and-mortar travel agencies. The younger generation tend to prefer free and easy travel plans and purchases theirs accommodation and air tickets from online travel agents. Few people purchase their tickets/accommodation straight from the service providers' website. The main inconvenience here is that, it is too troublesome to surf site by site to compare prices and dates.
However, there has been political pressure from developed countries for the China government to deregulate the Chinese GDS market. This culminated in the opening of the booking for non-chinese airline tickets to foreign GDSes. What this means is that, foreign GDSes can now compete in the area of making booking of air tickets from foreign airlines tickets. This I believe is restricted to mostly international flights. Domestic flights are covered by domestic airlines and remains in the grip of TravelSky Tech. The Chinese government has a history of grooming domestic champions to compete with international peers. Thus far, they have been very cautious when it comes to liberalizing any sector or industry. The CNY is one good example, where they have experimented with partial liberalization in Hong Kong to test the results. I believe the same will occur here in the travel GDS industry. Completion liberalization is probably going to take quite some time, perhaps in the order of 5-7 years. The current opening of foreign airline ticket booking to international GDSes will not hurt TravelSky Technology too much. As of end 2012, TravelSky Technology processed 330 million bookings for Chinese commercial airlines, compared to 16 million on foreign and regional commercial airlines. The monopoly is largely intact.
| Booking on Chinese commercial airlines ('000s) | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 |
| International | 28,097 | 25,469 | 24,219 | 30,975 | 34,644 | 38,388 |
| Domestic | 167,853 | 177,318 | 216,173 | 249,678 | 271,085 | 292,282 |
| Total | 195,949 | 202,787 | 240,392 | 280,653 | 305,729 | 330,670 |
| Growth (yoy) | N.A. | 3.5% | 18.5% | 16.7% | 8.9% | 8.2% |
| Booking on foreign & regional commercial airlines ('000s) | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 |
| Total | 8,405 | 8,395 | 8,573 | 11,115 | 12,832 | 16,363 |
| Growth (yoy) | N.A. | -0.1% | 2.1% | 29.6% | 15.5% | 27.5% |
To prepare for the internationalisation the business, TravelSky Tech has been working on acquiring a larger inventory of international hotel rooms and international air flights. This involves negotiating with hotels and airlines in other countries to list their inventory and plug in to TravelSky Tech's system. A quick way to do this is to simply to form alliances with international GDSes, which in this case the partner is Sabre. I see this as an arrangement which benefits TravelSky Tech more than Sabre. Sabre wishes to tap on the growing population of chinese consumers that are travelling for leisure. However, they have limited distribution and inventory in China. The partnership gives Sabre the inventory, but they still need time and resources to build out their distribution network with chinese travel agencies. TravelSky Tech however, has an pre-existing distribution channel and relationships with domestic travel agents. By accessing Sabre's inventory of offshore hotel rooms and airline line flights, TravelSky Tech can immediately offering international hotel and air flight bookings to its customer base. Why does Sabre do this then you might ask? Because travel in Europe and the US is a mature market and growth rates are low. In order to grow, Sabre has to gain access to emerging market consumer, which China is the largest.
| Income Statement (RMB m) | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 |
| Revenue | 2,002 | 2,271 | 2,620 | 3,054 | 3,672 | 4,061 |
| Busines taxes and surcharges | (66) | (82) | (92) | (109) | (134) | (104) |
| Depreciation and amortisation | (243) | (333) | (341) | (404) | (406) | (331) |
| Network usage fees | (84) | (94) | (81) | (74) | (55) | (56) |
| Personnel expenses | (272) | (430) | (487) | (617) | (678) | (855) |
| Operating lease payments | (69) | (79) | (73) | (54) | (98) | (122) |
| Technical support and maintenance fees | (154) | (171) | (154) | (161) | (192) | (212) |
| Commission and promotion expenses | (248) | (241) | (273) | (393) | (452) | (491) |
| Other operating expenses | (210) | (230) | (320) | (256) | (475) | (671) |
| Profit after operating expenses | 657 | 612 | 798 | 988 | 1,182 | 1,218 |
| Financial income, net | 49 | 93 | 84 | 35 | 74 | 58 |
| Share of results of associated companies | 13 | 18 | 21 | 24 | 27 | 29 |
| Profit before tax | 719 | 723 | 904 | 1,047 | 1,283 | 1,304 |
| Tax | (70) | (68) | (109) | (130) | (208) | (142) |
| Net Profit | 649 | 655 | 794 | 917 | 1,075 | 1,163 |
| No. of shares (m) | 1,776 | 1,776 | 1,951 | 1,951 | 2,926 | 2,926 |
| Revenue growth rate | N.A. | 13.5% | 15.3% | 16.6% | 20.2% | 10.6% |
| Net Profit growth rate | N.A. | 0.9% | 21.4% | 15.4% | 17.3% | 8.1% |
| EBIT Margin | 32.8% | 26.9% | 30.5% | 32.3% | 32.2% | 30.0% |
| Net Margin | 32.4% | 28.8% | 30.3% | 30.0% | 29.3% | 28.6% |
TravelSky Tech has seen consistent top line and bottom line growth averaging mid-teens over the last five years. 2012 was a slow down for the company as growth of the Chinese economy moderated. As the Chinese economy continues to restructure from export driven to a consumption based economy, I expect revenue to grow at mid to high single digits. However, when the world and export recovers, I believe revenue growth can rebound to ~15%. Operating and net margins have been very stable for the business.
| 2007 | 2008 | 2009 | 2010 | 2011 | 2012 |
| CFO | 721 | 470 | 700 | 1,303 | 1,319 | N.A. |
| CAPEX | (568) | (363) | (259) | (2,345) | (212) | N.A. |
| FCF | 153 | 107 | 441 | (1,041) | 1,107 | N.A. |
Historically, TravelSky Tech generates a decent amount of free cashflow. 2010 capex was abnormal for TravelSky Tech. That year, the company spent close to RMB2bn on land use right. That is not capex related to their business. Excluding that, FCF for 2010 comes up to about RMB1bn. For TravelSky Tech, the resource intensive part of the business is at the start, when it needs to construct its system and build relationships with travel agents, airlines and hotel operators. Once that has been done, it does not take a lot of capex to maintain or growth its business.
| 2007 | 2008 | 2009 | 2010 | 2011 | 2012 |
| EPS | 0.37 | 0.37 | 0.41 | 0.47 | 0.37 | 0.40 |
| DPS | 0.13 | 0.186 | 0.134 | 0.157 | 0.120 | 0.133 |
| PE | 10.8 | 10.7 | 9.7 | 8.4 | 10.7 | 9.9 |
| Ex Cash PE | 8.2 | 8.2 | 7.4 | 6.4 | 8.2 | 7.6 |
TravelSky Tech currently trades at a trailing PE of 10x. I believe this is a fairly cheap for a business model that enjoys a monopoly, stable margins and generates decent amounts of cash. It has about HKD$1.1 of net cash per share sitting on the balance. Ex-cash, TravelSky Tech trades at a trailing PE of 7.6x. While I believe it is cheap, I have yet to initiate a position. My estimate for fair value for this stock is 12-13x PE, which is HKD$6-6.50. It doe not not hit my investment benchmark of identifying and buying stocks trading 40% below their intrinsic value. I would continue to watch this stock for sure. What I would really love here is a fall in the stock price.
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