January 24, 2000 - PriceLine.com: Where is the thrift?
It is the dot com on the end of PriceLine combined with the dramatic revenue growth which allows its stock price to be so richly valued (9.3 Billion market cap). To understand how the company operates one need look no further than were most of their revenues are derived from - Airline Ticket sales. PriceLine is essentially a middle man which has set up a platform by which consumers can offer a price for a item or service to a supplier (Priceline affiliate). It is not an auction based system but a "name your own price" model, meaning if you want to go to New York city for 200 bucks you tell Priceline and they try to make it happen. This is an ingenious concept which has created much attention. But PriceLine has a unique and complex relationship with some of its suppliers which is subject to an endless amount of scrutiny. Not only do the costs associated with attaining its relationships possibly infringe upon long term shareholder value, in many instances they are non-binding in the sense of real time and have many controlling aspects. To begin to understand the relationship first look at the process of reporting. Financial Statements All quotes taken from PriceLine November 18, 8-K SEC filing. "With respect to our airline ticket and hotel room reservation services, we recognize as revenue the amount we receive from the customer, net of taxes, and record as the cost of revenue the amount that we pay the selling airline or hotel." What this means is that PriceLine records revenue for transferring funds and the actual money they keep (real revenue?) is listed as cost of revenue. By comparison: A quick look at GM displays the financial statement in this manner Total Net Sales & Revenue - 42,453 Total Costs & Expenses - 39, 495 -- These numbers would mean GM has earnings before taxes and other related items of 2.9 Billion PriceLine.com (example) Revenues 1 Billion Cost of revenues - 900 Million + (Supplier Warrant Costs <time based>) Gross Profit - 100 Million *The gross profit by comparison to GM now becomes Revenue Gross Profit - 100 Million Total Costs & Expenses - 400 Million -- Through a complicated and misleading system of discovering revenue PCLN now shows a $300 million loss. This is a simple example of how revenues are deceptive in this internet age. In a normal, easy to understand income statement like GM the revenues minus the expenses give you the profit before taxes but with PCLN it is gross profit minus expenses. Why the SEC allows this deception to become prevalent inside not only PriceLine.com but many other internet related stocks is baffling. Did PriceLine really record revenues of over $300 million for the nine-months ended Sept 1999? In my book they recorded just over $35 Million in revenue. (Revenues - 313,196,643 Cost of Revenues - 277,951,680) Technically speaking if the margins remained the same PriceLine.com could come out one day and say "$3.1 Billion in revenues!" and that would sound nice. What Priceline doesn't want you to know is that only $350 million would be heading to the companies vault before the expenses are taken into consideration. Supplier Relationships & Dilution PriceLine sets up many of its affiliates with airlines and hotels by offering stock (preferred and warrants) as a form of payment. There is no better deal if you own a Airline; someone comes up to you and says "here is 10 million in stock, can we buy the tickets you don't sell?" . Besides writing down $88 million as an expense (not recorded as a cost of revenue) in what the company terms "Supplier start-up warrant costs" for the nine months ended Sept 30th , they have also continued this practice with vigilance. " We will incur additional supplier start-up warrant costs of approximately $238.2 million during the fourth quarter of 1999" Paying off suppliers to come join their system is what they do but if you incorporate over $300 million in these possible expenses inside a one year period and only post revenues of $35 million (my calculations) you are operating in a strange fashion. Also add to the mix of expenses as of the third quarter another $83.8 Million for Marketing, General & administration, and R&D. Strange indeed. From my understanding the AirLines (number one rev generator) hold all the cards in this "supplier" relationship. "We currently have 28 participating airlines. However, our airline participation agreements: - do not require the airlines to make tickets available for any particular routes; - do not require the airlines to provide any specific quantity of airline tickets; - do not require the airlines to provide particular prices or levels of discount; - do not require the airlines to deal exclusively with us in the public sale of discounted airline tickets; - generally, can be terminated upon relatively short notice. How does PriceLine hope to maintain or solidify their long term relationships with these AirLines? " can be terminated upon relatively short notice." . Perhaps I playing devils advocate, it just seems that if I owned an Airline I would be more than willing to take free money (shares) to sell tickets I don't use anyway. The point is if I am in no way obligated to stay with Priceline and market conditions change or better relationship develops what is to stop me from leaving? As recently as Jan 19 America West exercised 294,109 warrants on Priceline stock. This is not a strange occurrence because as companies are allowed to exercise their warrants they usually do, but it is a trend: - The company sold 1 million shares for cash on August 17 - Untied Airlines received 5.5 million warrants on November 15 exercisable at $52.625. - There are currently 26,685,778 non-qualified stock options which were given to employees exercisable at $12.61 a share. In many ways the company is smart because they are using their inflated stock price as a bargaining chip to do business. This puts less constraint on their negative cash-flow and gives them some room to invest in the bull market (net cashed used in investing activities for the nine months ended Sept 30, 99 of $97.4 million -- $77 million in short term investments posted on balance sheet). It is easy to do business in this manner during a bull market when relationships can be made by the signing over of warrants, the risk is that without sound supplier relationships a slip in stock price could strain the companies entire infrastructure (UA wouldn't be pleased if price went below $52). Another long term risk which means nothing right now is massive dilution. Margins & The Unknown Internet Age How can the margins ever arrive? The service after all is people bidding below regular price. "We are unlikely to make significant profits unless we make new or complementary products and services and a broader range of existing products and services available through the priceline.com service." At least PriceLine recognizes the margins will never arrive so transactional volume and the vast diversification of revenues is the way to go, but perhaps the major problem is not expanding so much as expanding efficiently. Even if "actual revenues" can continue their inclination for many years to come PriceLine may still have its hands tied. - What happens if attracting new clientele becomes a more expensive pursuit as companies decide shares in a stagnate stock isn't appealing? - What happens if Delta (currently has control over most aspects of airlines on Priceline) feels that they can undercut PriceLine by incorporating a similar hip software idea into their own website? www.deltaairlines.com/ To combat these worries Priceline announced a new Yard Sale site on Jan 19 by which supplier uncertainty can hopefully be diminished. I do not see the difference between the new site and what countless other top tier companies are trying to do; EBAY, YHOO, AMZN, & MSFT to name a few. One could argue that Priceline is trying to do too much and doesn't concentrate on the "thrift" aspect of their business model, couldn't they? One thing is certain, many suppliers may not be to pleased if the stock in which they hold warrants in takes a dive so an alternative source of revenue is a must for the company to keep the dream flowing. Closing As PriceLine.com signs up more suppliers and creates an aura of growth they may be in fact fulfilling a business model which can be duplicated by many current suppliers and future middle men. (PriceLine is and will always be in court concerning this matter they have one patent and have already filed against Microsoft for infringement). To those who speculate that the airlines and hotels will always continue to use Priceline to sell their unused tickets I boldly disagree. It is business after all and the major suppliers will always move to were the best incentives and profits are. To those who adore PriceLine.com and steadfastly state "you have to look long term, the internet is in its infancy" I reply; I am looking long term. All I see is a labyrinth of fallacious trust in what should cause commanding concern. It is not about loving the internet its about not knowing what the internet will become. Jan 28 Priceline.com's Earnings "Revenue for the full year 1999 was $482.4 million, with $59.4 million in gross profit and a net loss of $52.5 million or $0.39 per share.". Remember Priceline reports revenue when they transfer money for the goods (tickets) they purchase. In essence they have no inventory but money that would of been spent on inventory is recorded as revenue. Here is the real data on PriceLine.com for 1999 Revenue - $59.4 Million Loss (not including expenses) - $52.5 Million Non-Cash related Warrant Costs - $973.6 Million "Including such items, reported net loss for the fourth quarter and full-year 1999 were $921.5 million and $1.1 billion respectively.". It is amazing what a high stock price can be used for these days. As long as the share price of PCLN remains high they can continue to function in their current manner. CNBC.com had an article on PriceLine yesterday (mostly bullish). One analyst stated "These guys have probably been the most consistent in outlining a clear path to profitability, and they're consistently powering their net loss in each quarter," .Do people not understand how PriceLine does this? Priceline uses their stock (smart) to power the daily operations of the business but how hard is it to narrow your net loss when your largest expenses not included? |