Orbitz’ Heavyc Baggage

When Orbitz Inc, the Web travel agency owned by five of the nation’s

biggest airlines, filed financial documents with the Securities & Exchange

Commission (SEC) to go public in May, investor reaction ranged from respectful

to giddy. After all, Net travel site Expedia Inc and discount hotel-room player

Hotels.com have shown that the business can be solidly profitable.

"Expedia has been a really hot company and a good investment," says

William Smith, president of IPO Plus Fund in Greenwich, Conn. "Orbitz is a

nameplate IPO, and it will be a hot deal."

Maybe not. An examination of Orbitz’ newly disclosed financial information

raises questions about the company’s prospects. For starters, it still loses

money–$8.9 million in the first quarter, on sales of $32.2 million–even

though every other public Web travel company is profitable. And Orbitz could

have trouble growing its way to the level of profitability that Expedia and

Hotels.com have. The SEC filings reveal that Orbitz’ contracts with the

company’s five founding airlines call for the per-ticket commission rates the

airlines pay Orbitz to fall 15% to 30% annually through 2007.

Worse, Orbitz is running low on cash. It had only $39 million as of Mar 31.

The company expects to raise $125 million in its offering, but the IPO market

has cooled considerably since Orbitz filed with the SEC. Without new money,

Orbitz could face a cash crunch as early as next year. "I think the reason

Orbitz is doing an IPO is that it has no other choice," says Philip Wolf,

president of Web travel consulting firm PhoCusWright Inc.

Nonsense, says Orbitz. Jeffrey G Katz, the company’s chairman and chief

executive, makes the case that Orbitz is healthy. He says the summer travel

season and Orbitz’ rising sales of hotel rooms will head off any cash squeeze,

with or without the offering. He also says that Orbitz will have at least one or

two more quarters of financial results to show its growth plans are working

before it goes public. "When we’re on our road show, we’ll have data to

answer questions" about growth, he says.

Still, Katz may face a tough sell once investors understand how Orbitz’

corporate governance is structured. United, American, Delta, Northwest, and

Continental set up the company, and the airlines will control six of nine board

seats after the IPO. Katz says the airlines have a vested interest in Orbitz’

success. But the partners’ control raises questions about possible conflicts

of interest. If the interests of the airlines and Orbitz’ other shareholders

diverge, which group will Orbitz try to satisfy?

The SEC filings suggest that so far, the airlines are the top priority.

Example: Orbitz’s decision, implemented last December, to begin charging

consumers a $5 per ticket reservation fee–a charge that rivals, such as

Expedia, don’t levy. That fee serves a long-standing goal of the airlines to

shift more of their distribution costs to consumers.

But the $5 fee could hurt Orbitz’ popularity. While the company has

positioned itself as the lowest-cost travel site, consumers are finding that’s

typically not the case these days. In a June 6 report, Consumer Reports wrote

that Expedia, not Orbitz, is now the low-price leader for airfare. A

BusinessWeek analysis of 10 hypothetical weekend jaunts reached a similar

conclusion. Including the $5 fee, Expedia was cheaper than Orbitz for eight

trips, while Orbitz was less expensive in two cases. That’s dangerous because

Forrester Research Inc’s analysis shows that 6 out of 10 customers aren’t

loyal to any one travel site. "You’re only as good as your last

deal," says Forrester analyst Henry H Harteveldt. Katz says the fee has not

cost Orbitz market share.

A more important strategic lapse is Orbitz’ failure, so far, to enter the

most profitable part of the travel business. Instead of simply selling airline

tickets and hotel rooms for commissions, successful sites such as Expedia also

use what they call a "merchant model." They negotiate discount prices

for large blocks of hotel rooms or vacation packages, then mark up the prices

and sell them to consumers. Although travel agencies forego commissions, the

merchant model is far more profitable because a typical $6 airline ticket

commission is dwarfed by markups that can hit $500 on a vacation package. Orbitz

had no merchant-model revenue in the first quarter, though it’s inching into

the business. "That decision came back to bite them on the tuchus,"

says Phil Carpenter, vice-president of travel-shopping service SideStep.

Analysts chalk up Orbitz’ slow entry into the merchant business to airlines’

resistance. Why? The key to success in the merchant model is for the travel

agency to force down the price it pays for hotel rooms or airline tickets. Katz

says Orbitz will get into the merchant business eventually. Meantime, the

company started into the business indirectly in June. It began listing hotel

rooms on its Web site that are offered by Travelweb.com, a hotel-industry-backed

merchant site that pays Orbitz a commission for each sale.

Certainly, there are reasons to like Orbitz’ prospects. Launched last June,

the Chicago-based site sold $542 million worth of travel in the first quarter,

making it the third-largest online agent, behind Expedia and Travelocity.com.

Orbitz began with one big advantage: access to special low-cost fares that were

available only on Orbitz and the airlines’ own Web sites. Those "Web

fares" terrified rivals, who are trying to get them declared an antitrust

violation. The Transportation and Justice Departments are evaluating the claims,

and a report from Transportation is due soon. But, analysts say, Expedia and

Travelocity now get most of the Web fares that Orbitz does.

Katz argues that Orbitz can overcome the business and antitrust challenges it

faces. He has high hopes, in particular, for a technology, set to be introduced

later this year, which will overhaul the arcane economics of selling airline

tickets. Right now, travel agencies rely on technology from companies such as

Sabre Holdings Corp to sift through the airlines’ ever-changing fare schedules

to find itineraries. Airlines pay about $10 per ticket to let travel agencies

conduct such searches. Katz says that Orbitz’ new technology, called supplier

link, will let the airlines cut out Sabre and its peers. Orbitz and the airlines

plan to split the savings from such fees, which total about $1.5 billion each

year.

With all its challenges, Orbitz may have a hard time living up to its billing

as a hot IPO. Even Katz says he may not rush to go public. "When we go

public is a function of when the timing is right," he says. Holding off may

make the most sense for Orbitz–and for investors.

By Timothy J. Mullaney in New York in BusinessWeek. Copyright 2002 by The McGraw-Hill Companies, Inc