Investing in Travel

ITRV
Guest article written for AllAboutAlpha.com – the official publication of the  Chartered Alternative Investment Analyst (CAIA) Association

Originally posted at: http://allaboutalpha.com/blog/2012/12/04/alpha-hunter-investing-in-travel/

The WTTC note that the travel industries (when taking into account their direct and indirect roles) contribute over 9.1% to world GDP, amounting to over U$6.3 trillion of economic output and sustaining 1 in 12 of all global jobs (around 255 million people).   Looking at the USA alone, travel and tourism amount to over 10% of the country’s GDP, supporting 14.4 million jobs and contributing over $120 billion in tax revenues.

This is a hugely segmented industry which (as Timothy O’Neil-Dunne states), “….inspires because it has a huge emotional component, everybody feels very attached to it.  At the same time, it’s incredibly complex- and full of mind-bogglingly stupid things that make it more complex than it needs to be….”   It is this factor of complexity which translates (to many investors) as being an indication of risk or even a lack of scale opportunities.  In the latter case, looking at just three members of one segment (the Online Travel Agency space) – Priceline (with a market cap of U$32 billion), Expedia (with a market cap of U$8.1 billion) and Tripadvisor (with a market cap of $5.4 billion) – show that this assumption, of a lack of scale, is clearly false.

The fact is, travel is one of the few industries that impacts practically everyone in the world economy.  It’s strange therefore that this is a sector lacking in investment momentum. To learn more about investing in the travel space, I spoke with Timothy O’Neil-Dunne, Managing Partner at T2Impact Ltd, co-Founder of VaultPAD Ventures and one of the original founders of Expedia.  He has published 3 books in Travel Distribution and Aviation. Mr. O’Neil-Dunne is a frequently quoted and a commentator in travel and technical journals and is a permanent advisor to the World Economic Forum.

Q: What is the state of the global travel industry?

[Timothy O’Neil-Dunne] The industry is so big that it’s difficult to give a general read of its state.  It’s a bit like saying ‘what’s the state of the global banking industry?’ You could do a broad-brush and say that the banking industry is full of corrupt individuals intent on defrauding the world, or you could say that in some markets banking is doing very well- and in others it’s doing terribly.  It’s the same analogy in travel.    There are some sectors that do well, for example- China is growing in leaps and bounds, albeit not as fast as people think it might do. The price conscious traveller is the guy who is very much in control… he is the chap who determines many things.  You would think that is mostly a demand-size business.  In actuality, it’s becoming increasingly- on one side of travel- a supply side business (because of supply constraints).   The factor that is becoming supply-side dominant is air and air-travel!  There’s always been a discrepancy between the occupancy (use of feed stock) of air versus hotels.  If you go back around 10-15 years, you would see they were in synchronisation- operating at c.70% occupancy.  Now, due to a number of issues such as airline consolidation, there is a tighter level of this, and some airline models- such as the low-cost model, make money.  Broadly, airline space now operates at around 80% occupancy, and the hotel space at around 70% occupancy.   This means that the airlines have pricing and control power in the market.  It becomes harder and harder over time to recognise ‘who’ has the power in the market.  You assume there is a good healthy intermediary, supply and consumer market.  There are a lot of conflicts in that- and these complexities and conflicts keep on coming.  The result? This is a market that lives in constant-flux.

Travel is a market that will always do well, in the absence of one of two factors.  Firstly… if the global economy goes soft- since travel is a discretionary spend- it will go soft faster than the rest of the economy.  Secondly… if there is ever an event that cause travel to be inhibited (such as SARS, 9/11, volcanic ash and so on…) it has a ripple-out effect.  For example, the recent super-storm ‘Sandy’ caused 1-2% of entire US air traffic capacity to be lost.  You may think you could make this up, but you cannot get this number of people back into the system even when you’re working at 90-97% efficiency.  It means that a lot of people cancelled and couldn’t travel.  When you’re typically operating at 2-5% margin? …that has a huge impact in your numbers. That said, travel has a huge amount of resilience too – things were back to normal after 9/11 in just 3 months.

Q: What are the key investment opportunities in travel?

[Timothy O’Neil-Dunne] There are a number of areas where the opportunities exist.  If you look at the supply-side of travel, it’s very tough.  There are huge expenses, high risks, and low returns.  Typically people don’t look at supply and infrastructure, where they do look is within the intermediary market.  If you break the market into distribution and intermediary management, there are a number of really nice areas that open up. Firstly is the area of non-travel (but travel related) services.  These could be things like tours and activities… the things that you do when you travel on leisure…. This is a huge market, and so badly serviced that it needs resolving. Another area in terms of product is rather interesting.

In travel, we are seeing a sea change occurring…  The primary users of travel have, in the past, been baby-boomers.  They defined the marketplace.  This group are now leaving the market in terms of leisure and business travel, and being replaced by people who are younger and with different characteristics.  Appealing to a different user community is an opportunity for a lot of people. The market for the OTA (Online Travel Agency) world has been pretty well understood for a long period of time.  That world however, is changing.  There is a dynamic conflict around price transparency. The consumer is far better educated today than he ever was.  Consumers don’t need to rely on intermediaries to tell them what is good or bad- people are social, they share information with friends and strangers, and go to a broader community for help and assistance.  This is part of travel’s evolution… You are only ever one click away from looking at another alternative…  The ability for the consumer to shop-around has made it difficult for some operators to realise the need for transparency in pricing… particularly when your product is built around opacity.  Airlines for example, do not want you to know what the lowest price is.  They want you to choose the highest possible price so they can get money out of you in the direct and ancillary environment… yet the web, where most bookings are now made? Is all about transparency.    This opacity is the difference between profit and loss.  If every airline seat that could be sold- were sold at the lowest possible price, the industry would lose billions.  If every airline seat that could be sold- were sold at the highest possible price… It would make billions.  Moving that needle towards opacity rather than transparency is the constant battle that exists between airlines and the consumer.  Understanding how you can balance this is a huge opportunity. If things moved to true-transparency, and you could verify that transparency- trust in the airline brand would rise.  If you move it completely the other way, trust falls to an all-time low.  Airlines today, as a result of their ability to consolidate and control markets, are moving more toward opacity.  Consequently, the trust in brands is lessened and people search much harder.

Q: Do you feel that investment opportunities exist in airlines themselves?

[Timothy O’Neil-Dunne] Airlines are somewhat cyclical.  If you go back to around 1995, this is when airlines were paying the most for distribution- usually in commission fees.   The airlines started to cap-this and bring it down, and today- there are no commissions- only marketing costs.  There was a diversion of money from travel agents to marketing channels on the web- particularly Google.  Google is hovering up a lot of the money that used to go to travel agents.  Airlines still see a huge cost in marketing and distribution.     Anyone who wants to show that airlines are making profit, have to deal with that problem.. A more positive story comes from Delta, who are now approaching 10% gross margin.  They have kept their capacity in-check, and have been judicious in their management of distribution.  If you go back 15-17 years, there were 10 airlines in the US market  (including Pan Am, Eastern and TWA who no longer exist) and competition was much fiercer.  Today? There are only five major brands in the US market.  They have very little competition.. The real spoiler was Southwest Airlines.  They made a decision earlier this year not to act as a market-disruptor for at least 5 years.  They did this through his purchase of aircraft.  Even if he wanted to, he couldn’t disrupt the market- there are no delivery slots available for him to put aircraft into the marketplace. The opportunity cost for an asset owner or lessor (such as Boeing or GE) and the opportunity revenue that you can get out of deploying that asset in the market is pretty high on a marginal basis, but you don’t want to overdo it… so by constraining it, you have the ability to be in pricing control.

Q: Do you feel there are investment opportunities in travel technology?

[Timothy O’Neil-Dunne] I really think we’re at the first generation of web and travel.  It’s all about access… Going back to 1995, around 80% of all travel went through agencies and 20% went direct. Fast forward today, and there are a vast-array of channels, but the consumer is just as confused as they were in the 90s. Technology is no longer just about access.  To all intents and purposes, everyone who researches travel starts online.  Google has not been the leader of where you search, it’s gone to the meta-search and OTAs such as Expedia.  Market characteristics vary.  In the US, airfare is paramount- and in Europe, trip-cost is paramount.  There are huge opportunities to create a more natural form of interaction in terms of searching-for and acquiring travel.  There’s a huge gap between the inspiration side of travel (where many people are investing money) and the execution into the purchase path.  That latter part of the process is so universally horrid that everyone hates it- and nobody is doing anything about it. Technology also allows you to open niche sectors, but investors have to identify these opportunities more clearly.

What does this mean for investors and risk managers?

For investors, the opportunity is to broaden their horizons and realise that rather than being individual segments- travel (like many large sectors) requires a portfolio approach, and offers significant return opportunities. For risk-managers, the message is much the same.  Travel is a market which like any has risk-factors, and is exposed to economic volatility.  Risk managers cannot apply their standard cyclical or other models to understand an industry like travel, the challenge (and opportunity) now is to create new models of risk management, which suit this fast-paced and rapidly changing market.


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