Kayak Software: Riding The Wave Of Interest In On-Line Travel Search

Based in Norwalk, CT, Kayak Software (KYAK) scheduled an $82 million IPO with a market capitalization of $907 million, at a price range mid-point of $23.50 for Friday, July 20, 2012. KYAK will sell 9% on the IPO, a relatively low IPO percentage.

Most recent S-1 filed July 9, 2012.

Initial S-1 filed November 17, 2010. KYAK was postponed May 30, 2012

KYAK is a travel search engine. For the four quarters ended March 2012 KYAK generated $245 million in revenue, and $17.5 million in after-tax income, see ‘FINANCIALS’ below.

SUMMARY
KYAK is a travel search engine. For the four quarters ended March 2012 KYAK generated $245 million in revenue, and $17.5 million in after-tax income, see ‘FINANCIALS’ below.

A concern to investors is KYAK’s reliance on the ITA contact for airline search inquires. The contract expires the end of 2013 and ITA is owned by Google (GOOG), a competitor.

KYAK, however, has substantially reduced it’s reliance on ITA results. For the nine months ended September 2011 ITA produced 61% of KYAK’s airline search inquires. The four months ended April 2012 that percentage dropped to 39%.

It was smart of Kayak to postpone its IPO on May 30 for two reasons:

(1) KYAK Needed to get out of the way of the Facebook (FB) pricing disaster.
(2) The travel search group of Orbit (OWW), Trip Advisor (TRIP) & Expedia (EXPE) continued to go up in the last month. As a group they are up 36% on average in the last three months.

KYAK expects to ride the current wave of investor interest in travel search companies.

VALUATION COMPARISON
Relative to TRIP
. Kayak's gross margins are similar (above 92%)
. Kayak's is priced at a premium price-to-earnings multiple (52 to 34)
. Kayak is priced at a price-to-sales discount (3.7 to 9.2)

CONCLUSION
IPOdesktop believes that KYAK will be priced favorably for initial IPO investors.

BUSINESS
KAYAK’s services are free for travelers. KYAK offers travel suppliers and online travel agencies (OTAs), an efficient channel to sell their products and services to a highly targeted audience focused on purchasing travel.

KYAK earns revenues by sending referrals to travel suppliers and OTAs and from a variety of advertising placements on KYAK websites and mobile applications.

Cofounders of Expedia, Travelocity and Orbitz started KAYAK in 2004 to take a better approach to finding travel online.

KYAK SPENDS MORE ON MARKETING
Notice below that KYAK spent 56% of revenue on marketing, compared to the average for Orbitz (OWW), Expedia (EPXE) & Tripasvisor (TRIP) of 39% for the three months ended March, 2012.

As a result of spending so much on marketing, KYAK’s after tax profit margin was 7% compared to TRIP's after-tax profit margin of 27% for 2011.

On a go forward basis is that there is room for Kayak to increase its after-tax profit margins, if it can get it’s per cent of revenue marketing expenses more in line with OWW, EXPE & TRIP.

SLIGHT POSITIVE
Concurrent Private Placement
Up to $9.2 million of Class A common stock may be issued at the initial public offering price, if the initial public offering price is less than $31.09 per share.

RELIANCE ON Google’s ITA DECLINING
ITA overall airfare query results dropped from 61% to 39% from September 2011 to April 2012.

S1 filing dated November 23 2011

“This faring engine software directly provided approximately 61% of our overall airfare query results for the nine months ended September 30, 2011. Additionally, 26% of our overall airfare query results during such period were obtained from other sources which, in turn, utilized the ITA faring engine software.”

July 9, 2012 S-1
“This faring engine software directly provided approximately 39% of our overall airfare query results for the first four months of 2012. Additionally, 16% of our overall airfare query results during such period were obtained from other sources which, in turn, utilized the ITA faring engine software.”

ITA ISSUE
In July 2010, Google (GOOG) announced an agreement to acquire ITA Software. ITA licenses its airfare search and pricing software to Kayak under an agreement which expires in December 2013.

With the regulatory approval of the acquisition in April 2011, Google can create its own flight search tool which enables people to find comparable flight information on the Internet without using Kayak’s services. Click Here

The ITA faring engine software directly provided approximately 39% of KYAK’s overall airfare query results for the first four months of 2012. Additionally, 16% of KYAK’s overall airfare query results during such the same period were obtained from other sources which, in turn, utilized the ITA faring engine software.”

ITA Software, division of Google

ITA SERVICES AGREEMENT
On March 3, 2005, KYAK entered into a Services Agreement with ITA for the licensing of airline faring engine software. The agreement was subsequently amended on July 18, 2007, March 11, 2008 and January 1, 2009.

KYAK paid ITA an initial payment of $166,666 followed by a monthly service fee based on the number of queries performed, subject to a minimum of $83,333 per month, a software maintenance and operation fee of $225 per hour and a hardware fee per month of $1,450 per dual processor server used.

On March 11, 2008, in addition to KYAK’s arrangement with ITA, KYAK agreed to assume payment obligations of SideStep to ITA following KYAK’s acquisition of SideStep.

On January 1, 2009, KYAK agreed to amend the fee schedule as follows: to increase the monthly service fee to a minimum of $500,000 for the period until January 1, 2010, and a minimum of $583,333 per month thereafter until the aggregate payments for 2012 equal certain agreed-upon amounts, following which KYAK would cease such monthly minimum payments until January 1, 2013, whereupon KYAK agreed to pay a minimum monthly fee to be calculated based upon the number of queries performed in 2012.

For the period from January 1, 2012 through December 31, 2012, KYAK had an estimated minimum commitment of $7 million related to this agreement.
ALSO
Google threw in a surprise with the launch of a hotel search tool called Hotel Finder, announced August 2, 2011.

Google's (GOOG) Hotel Finder does not use ITA's technology and is being viewed as a threat to other travel search engines such as Kayak, Priceline (PCLN), Expedia (EXPE), Tripadvisor (TRIP) and Orbitz (OWW)..
ONLINE TRAVEL INDUSTRY
The travel industry in the U.S., Europe, Latin America and Asia Pacific accounted for $910 billion in global expenditures in 2011, and is projected to increase 6% in 2012. Of this amount, approximately $284 billion, or 31%, was purchased online in 2011 representing a 16% compound annual growth rate, or CAGR, between 2005 and 2011.

KYAK believes that travel, with its research and information intensive nature, real time pricing, electronic fulfillment capabilities and thousands of travel options, is well suited for the online channel.

Currently, online travel represents the largest category of e-commerce, with total sales exceeding the combined total of electronics, books, software, appliances and collectibles.

Online Travel Products
The two largest categories of online travel are airline ticket sales and hotel bookings. In 2011, airline ticket sales represented 53% of total online travel purchases, followed by hotel bookings at 26%.

Hotel bookings are the fastest growing online travel category and are projected to grow 13% in 2012. Given the significant differentiation among hotels, travelers will typically spend considerable time online researching a hotel stay, making hotel bookings highly suitable for the online channel.

Online Travel Advertising
Travel represents one of the largest advertising categories, with advertisers spending $33 billion globally on travel-related advertising in 2011.

Of this amount, only $5 billion, or 16%, was spent online with the remainder being spent primarily on traditional media.

KYAK believes that travel advertising will continue to move from offline to online as travel purchases continue to move online.

Online travel advertising can also be a more efficient advertising channel, because it enables advertisers to directly target individuals who are researching and planning travel. The online travel advertising market is expected to reach $9 billion by 2015, a CAGR of 14% between 2011 and 2015.

CUSTOMER CONCENTRATION
Expedia and its affiliated brands, including Hotels.com and Hotwire, together accounted for 23% of KYAK’s total revenues for the three months ended March 31, 2012.

KYAK has separate contracts with respect to Expedia and each of its affiliated brands, each of which have varying terms and expiration dates.

Orbitz and Priceline each accounted for 10% of total revenues for the three months ended March 31, 2012. KYAK’s contract with Orbitz expires on December 31, 2013.

INTELLECTUAL PROPERTY
KYAK has ten issued U.S. patents and eleven U.S. patent applications for various aspects of KYAK’s technology. KYAK’s patents expire at various dates between March 2021 and October 2026.

COMPETITION
Competition from general search engine companies could adversely affect KYAK by reducing KYAK’s website traffic to KYAK’s website and mobile applications and by creating a competitive product that people choose over KAYAK when searching for travel online.

In addition to its acquisition of ITA, Google has launched a travel search offering that displays hotel and airfare information and rates to travelers. Moreover, Microsoft acquired one of KYAK’s competitors, Farecast.com, in 2008 and relaunched it as Bing Travel, a travel search engine which not only allows users to search for airfare and hotel reservations but also purports to predict the best time to purchase.

These initiatives appear to represent a clear intention by Google and Microsoft to appeal more directly to travel consumers and travel suppliers by providing more specific travel-related search results, which could lead to more travelers using services offered by Google or Bing instead of those offered on KYAK’s websites and mobile applications.

For example, Google has launched the ability for users of its website to search for hotel and airfare pricing and availability, and as Google integrates such offerings with other Google services such as Google maps and weather information. GOOG competition could reduce the number of users that visit KYAK’s websites and KYAK’s ability to attract advertising dollars also could be negatively impacted.

According to Experian Hitwise, in September 2010, 30% of KYAK’s traffic to travel-related websites began with Google. Google or other leading search engines could choose to direct general searches on their respective websites to their own travel search service and/or materially improve search speed through hardware investments, which also could negatively impact the number of users that visit KYAKs websites and negatively affect KYAK’s ability to attract advertising dollars.

VENTURE CAPITAL
72% Pre-IPO owned by VCs

General Catalyst Partners, 30%
Sequoia Capital, 18%
Accel Funds, 14%
Oak Investment Partners, 10.6%

EMPLOYEES
185 employees and 61 contractors as of June 30, 2012.

USE OF PROCEEDS
KYAK expects to net $73 million from its IPO, and also $9.2 million from a concurrent private placement at the IPO price.

The proceeds are allocated to working capital and other general corporate purposes.