Potential pitfalls in a Priceline-Kayak deal

November 9, 2012: 9:20 AM ET

Investors cheered Kayak's proposed sale to Priceline as a windfall for shareholders. But the price may be too rich for some.

By Janet Morrissey, contributor

PricelinFORTUNE -- Priceline.com's decision to acquire online travel listings company Kayak Software Corp. for $1.8 billion is being hailed as a lucrative deal for Kayak shareholders. But for Priceline shareholders it looks somewhat pricey -- even questionable.

It hasn't been a long public run for Kayak (KYAK), but it's certainly been a profitable one. Shares of the Norwalk, Conn., company surged almost 30% in after hours trading Thursday after news of the takeover. Priceline's (PCLN) $40-a-share takeover bid represents a 29% premium to Kayak's closing price of $31.04 on Thursday and a 54% premium to its July IPO price of $26. Not bad for a company that went public less than four months ago amid much fanfare. "I think that's a pretty good return for the amount of time that Kayak has been public," says Michael Olson, a managing director and analyst at Piper Jaffray.

The deal caught many analysts and industry experts by surprise. "I was not expecting it," says Kevin Kopelman, a vice president and analyst at Cowen & Co. "Priceline has done acquisitions in the past, but they've never acquired a meta-search company."

Until now, much of Kayak's investor focus has been on the company's long and arduous journey to go public. Kayak, which first filed to go public in November 2010, encountered delays and setbacks that stalled its IPO until last Summer. Executives faced investor headwinds, as the fallout from the Facebook (FB) debacle, weak job numbers and the European debt crisis had shaken investor confidence in new listings. In July, amid market trepidation, executives pushed ahead with the IPO. They were rewarded as Kayak's stock got a first-day 28% pop. Its shares surged as high as $35 a share, before closing at $33.18, up from its $26 IPO price.

MORE: How Jeffery Boyd took Priceline from dot-bomb to highflier

And now, with a $40-a-share takeover bid, shareholders will enjoy a 54% gain from the IPO price. "We're excited to join the world's premier online travel company," said Steve Hafner, Kayak's chief executive and co-founder, in a statement. "The Priceline Group's global reach and expertise will accelerate our growth and help us further develop as a company."

Kayak is a travel research site that allows people to see and compare prices from hundreds of travel sites when searching for flights, hotels and rental cars online. It displays the options in one place and provides a link for the person to make the purchase directly from the company offering that rate. Kayak handles more than 100 million searches each month, and makes its money from referral fees when people click on the links to the other travel sites and from online ads.

Under the merger agreement, Priceline will pay $500 million in cash and $1.3 billion in equity and assumed stock options. Kayak's current management, which includes Mr. Hafner, will continue to run Kayak as an independent unit under the Priceline umbrella. Analysts expect the deal to have little impact on Priceline's earnings in 2013, but should be accretive in 2014.

However, reaction to the deal from Priceline analysts and investors is mixed. For some, the 29% premium to Thursday's closing price appears rich. Analysts estimate Priceline is paying about 19 times 2013 EBITDA for Kayak at a time when other online travel companies trade at a multiple of 11.5 on average. "It's a pretty big premium," says Kopelman. "It's a very high multiple -- a significantly higher earnings multiple than what Priceline trades at." Still, he says Priceline is paying up for Kayak based on its growth potential and the synergies the two companies could potentially enjoy.

MORE: What next for Kayak.com?

This growth will come from Kayak expanding further into the hotel space, which has higher profit margins than airfares, from its popularity in the mobile market, and from using Priceline's global expertise to beef up Kayak's international presence. "Strategically it makes sense," says Kopelman. Kayak is strong in the U.S. but doesn't have the brand recognition internationally yet. And Priceline's booking.com brand is strong in Europe, but not in the U.S. "So there is a potential for them to work together in a way that will help both companies," he says.

Brian Fitzgerald, an internet analyst at Jefferies & Co., estimates Kayak is poised to generate compounded annual growth of at least 30% over the next three years. "You have to pay a premium for a business that's growing this fast and has this many avenues of growth in front of it," says Olson. Still, some analysts wonder if Priceline could have purchased Kayak at a cheaper price if it had done the deal while the company was still private.

Some critics also question why Priceline is moving into the online meta-search market at a time when one of its rivals, Expedia (EXPE), last December exited this niche with the spinoff of its TripAdvisor business. One of the challenges that Expedia faced at the time was that rival travel sites, such as Orbitz and Priceline, stopped using TripAdvisor much once Expedia acquired it. "Priceline and Orbitz (OWW) didn't want to spend as much on TripAdvisor because they didn't want to line the pockets of Expedia or tip their hand competitively by giving away their advertising strategies because Expedia owned TripAdvisor," said one investor, who did not wish to be named. As a result, some wonder if Priceline could face a similar dilemma if rival travel firms start abandoning Kayak once it's part of Priceline.com.

Kessler dismisses this concern. "Kayak has become an important source of traffic for a lot of sites and I think it would be hard for them to walk away from it," he says. Proponents of the deal say the premium isn't as high as it appears. They note that Kayak's shares traded as high as $36.87 in October, before pulling back. "They're buying this because they think it has a lot of long-term value and feel it can be a lot bigger in five years," says Kopelman. "It's the number one travel meta-search site in the U.S."

MORE: How Kayak built the #1 mobile travel app

Then there's the cost savings the two companies can potentially see by combining the two firms' headquarters in Norwalk, Conn., consolidating administrative costs related to public company requirements, and no longer having to pay fees to get leads from Kayak, says Fitzgerald. "Priceline accounted for 10% of Kayak's total revenue in the second quarter, or about $7.7 million, so that's $7.7 million that Priceline doesn't have to pay to Kayak anymore," says Fitzgerald.

Supporters of the deal also note that Priceline has a history of making savvy acquisitions, such as Booking.com in 2005, Asian hotel booking company Agoda in 2007, and TravelJigsaw in 2010, which generated healthy returns for the company. Booking.com, for example, now accounts for more than half of Priceline's revenue and earnings, noted Kopelman. "It was a relatively small property that they built into a juggernaut of European hotel bookings and the reason today that Priceline is a leader in online hotel booking," he said.

At least three different law firms are investigating the Kayak sale for possible breaches of fiduciary duty by Kayak's board. They say they want to see if Kayak's board sufficiently shopped the company around to ensure shareholders got the best deal before agreeing to Priceline's offer.

Names bandied about as possible suitors for Kayak include Google (GOOG), Yahoo (YHOO) and even Amazon (AMZN). However, Olson says any possible acquiror had ample time to express interest and submit a bid in the long 19-month lead-up period to the company's IPO. "People knew for over a year that Kayak was in the IPO process, so there was plenty of time for other people to step in at that point," says Olson. He says he'd be surprised if another player made this a horserace now.

The acquisition, which still needs shareholder and regulatory approval, is slated to close in the first quarter of 2013.

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