TZOO - Travelzoo's Business Is Declining And Unprofitable

Summary

• TZOO is a digital publisher specializing in travel and experiences. The company has several websites that offer deals to readers. The deals are advertisements paid for by travel companies.
• The company's business declined before the pandemic started, attacked by aggregator competition. After the pandemic, revenues have not recovered.
• Recent operating income figures incorporate non-recurrent items, without which the company would have generated only operating breakeven.
• Finally, the company has governance issues. CEO's options were repriced at the onset of the pandemic while investors lost millions. The founder is selling a metaverse travel agency to the company for $9 million in stock.
• For these reasons, I believe TZOO is an easy pass.

Travelzoo ( TZOO ) is a digital publisher that offers its readers deals in tourism and travel experiences. The company owns several web pages, a newsletter, and smartphone apps through which it reaches customers. It charges airlines, hotels, and travel agencies for that reach.

The company's business declined before the pandemic and has not recovered as fast as other companies in the space. Although attractive at first sight, recent operating income figures are affected by non-recurring items, without which the company is only breaking even.

Further, the company engaged in private share issuance with its largest shareholder, through which it acquired a metaverse travel agency company for $10 million, which seems quite expensive.

For these reasons, I do not believe TZOO stock is a great opportunity now.

Note: Unless otherwise stated, all information has been obtained from TZOO's filings with the SEC .

Business

Travel and experience deals:

TZOO manages three business models around travel or experience deals.

Travelzoo.com, its associated Android and Apple applications, and the Travelzoo newsletter are the biggest. These sites and apps offer their readers travel, vacation, and experience deals for free. Airlines, hotels, and travel agencies publish in Travelzoo, paying TZOO in different advertising formats (impressions, clicks, conversions, etc.). Travelzoo.com operates in the U.S. and Europe and obtains (relatively low) royalty fees from licensees in Japan, Australia, and Asia.

The Travelzoo website also offers local deals and experiences. In this model, local restaurants, museums, spas, etc., either pay Travelzoo on an advertising basis or as commissions on vouchers sold.

Finally, TZOO owns jacksflightclub.com, a U.K. membership-based website that offers flight deals. The website is based on a freemium model, and the company does not disclose direct relations with airlines. JFC was not part of the business before the pandemic, as it was acquired in 2020.

Decaying business before the pandemic:

Most tourism and travel-related companies generated losses during the pandemic, many of them in 2021 too. However, TZOO's business model was already decaying well before the pandemic. The company's operating profits peaked around 2012, and its revenues did the same in 2014, as seen below. The company's Asian segment was generating consistent losses and was transitioned to a royalty-based system that is now generating negligible royalty income.

Competition from aggregators and alternatives:

I believe TZOO's main business model was attacked by aggregators in hotels and flights like Booking, Trivago, or Skyscanner. Instead of sending specific deals, these sites allow customers to filter for the best prices where and when they want. TZOO also mentions that alternative lodging arrangements, like Airbnb apartments, steal part of their share because owners do not advertise in TZOO.

High costs for low content:

Travelzoo.com (both travel and locals) does not offer much content that is not deals based. It has a blog section comprising less than 30% of the web's content. The company, therefore, should not spend a lot on content creation but only on customer acquisition and retention through advertising. The company reports around $3 million in advertising and customer acquisition expenses in FY21 and FY20 .

However, the company's SG&A expenses are much larger than $3 million, which puts a severe threshold on the scale the business has to achieve to be profitable. Again, the company does not generate much content outside of advertising. A visit to its webpage reveals what, in my opinion, also seems like a low investment in web design.

Recent developments

Post-pandemic:

Judging TZOO based on 2020 and 2021 performance is incorrect, given that all companies in the travel industry suffered from lower revenues.

However, while there are many examples of fast recovery from the pre-pandemic lows, TZOO has been relatively slow in regaining revenues. The examples below represent different segments of the tourism industry: aggregators, hospitality, cruises, and airlines.

Still unprofitable on a recurring basis:

TZOO has shown an operating income of $6.5 million in the 9M22 period . However, most of that income was generated by non-recurring items.

One item is $3.5 million in a reversal from voucher cancellations (the company records a reserve for vouchers that customers may cancel before using the service). Another $2.5 million come from a German government subsidy, for $1.7 million, and the sale of investment participations in a German company.

Removing these items, operating income from recurring sources is negligible.

A questionable acquisition:

In November, TZOO announced an agreement with its founder and controlling shareholder that the company would issue him 3.4 million shares (21% of after-issuance share count), valued at the time at $18.7 million. The problem is that the controlling shareholder would pay $2 million in cash, $8 million in notes payable during 2023, and the rest with all of the stock of MTE.

MTE is a company founded by the controlling shareholder that generates no revenues outside of Travelzoo and has 'significant operating losses' according to the company's report. The company is a metaverse travel agency an untested business model.

Yet, the implied price paid for MTE was $8 million. The market did not like this news, and the stock quickly slipped exactly after the announcement was made on November 25th, 2022.

After the stock had lost value, the agreement was repriced to $15 million , with $1 million in cash, $4.7 million in notes, and implied $9 million in MTE stock.

Option repricing:

Investors lost much money when the company's stock price fell while the pandemic was in full fledge. The normal would have been for managers to share the same fate as shareholders.

However, the options belonging to the company's CEO were repriced using as the strike price the stock's price from March 30th, 2020, according to the company's 10-K for FY21 . As the company's proxy statement shows , this cost TZOO $6 million in compensation. The company's CEO is the brother of the company's founder and controlling shareholder.

Upside risks

Metaverse appetite:

The market was eager to invest in companies related to digital assets and the metaverse in 2020 and 2021. That appetite has mostly faded in the current environment but could return. In that case, TZOO will be well-positioned to benefit from that trend.

Tax shield from MTE:

MTE's acquisition also provides TZOO with tax loss carryforwards that could help it shield future income. The amount of these carryforwards was undisclosed but 'significant', according to the company.

Negative economic context induced growth:

The company's operating income grew between 2008 and 2012, which is counter-intuitive given that the period included the GFC recession. However, TZOO's business could benefit from negative economic conditions because travelers look for better deals, even at the expense of optionality.

Conclusions

TZOO's business was declining before the pandemic. After the pandemic, the company has been unable to grow revenues or reach operational recurrent profitability, although there are numerous examples of recovery in the tourism industry.

Further, the company's cost structure seems too big for the operations required to run a business like TZOO's. SG&A expenses are ten times bigger than advertising expenses, even though the company generates relatively little content besides deals provided by its clients. This limits efforts to reach profitability.

Finally, the company's latest acquisition is questionable on business grounds, and managers have not shared the same fate as shareholders during the worse of the pandemic.

Trading at $60 million while generating very little operational income, TZOO seems an easy pass under the current circumstances.

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