Orbitz Takes Beating but Downside Now Limited

Not at first glance. Orbitz, a $768 million company, has several knocks against it compared to its larger competitors, and its shares have suffered amid increasing pressure from rivals. The stock's recent troubles trace back to early November, when Priceline.com (PCLN) announced it would no longer charge service fees to customers for airline ticket purchases. Since Orbitz gets most of its business from airfare bookings, its earnings could get hit especially hard if it has to follow suit.

In another blow, on Thursday investment bank Stifel Nicolaus downgraded the entire online travel industry to Hold from Buy on concerns about weak U.S. consumer spending. Thus Orbitz shares have fallen sharply from a high of $15 since the company went public in July. The stock closed on Thursday at $9.07, or 13 times expected earnings for 2008 of 71 cents per share, according to Thomson Financial. Analysts project average long-term growth of about 20%. By that measure, Orbitz shares are at a 53% discount to the S&P 500.

But if the market's hand-wringing turns out to be overblown, the upside potential to Orbitz shares looks good given the cheap valuation. Stifel analyst George Askew, in his research note Thursday, said that although Orbitz is particularly vulnerable to weakness in the U.S. economy because it gets the bulk of its bookings from North America, Orbitz shares "have limited downside." His calculation has Orbitz trading at a low forward enterprise multiple of 6.5, compared to 10.6 for Expedia and 16.0 for Priceline. The enterprise multiple is the ratio of a company's enterprise value to Ebitda (earnings before interest, taxes, depreciation and amortization), in this case adjusted Ebitda. The multiple is supposed to value a company the way an acquirer would.

Given the limited downside, what about the upside? The big driver for Orbitz is a new technology platform that should boost its international business, increase higher-margin hotel bookings and drive down costs. The first two points are particularly important since the main criticisms of Orbitz are that it is too U.S.- and airline-dependent.

Orbitz launched this new technology platform in the U.K. in July with its e-bookers brand and is extending it across Europe next year. The technology moves 13 separate businesses with individual systems and web sites, spanning countries across Europe, onto a single platform, which should reduce support costs. It also gives e-bookers new functions, including multilanguage and multicurrency capabilities, offering suppliers a more global customer base. As dry as this might sound, the technology upgrade is already yielding results. Orbitz has said that as it rolls out the technology in more countries, it expects to "realize further operating efficiencies which will result in improved margins and enhance our ability to sustain strong growth in our European businesses."

Earlier this week, Lehman Brothers analyst Douglas Anmuth upgraded Orbitz shares to Overweight, with a $13 price target. In addition to the technology upgrade, Anmuth points to Orbitz's solid cash flow and expects Orbitz to start buying back shares.

"The risk around booking fees is overdone," Anmuth said in his research report. "Orbitz gets little credit for its international [business] which should turn profitable in '08, share buybacks are likely going forward and valuation is compelling."

In the third quarter, Orbitz's international bookings rose 31%. And while Orbitz reported a larger net loss, on a pro forma basis it bested analysts' expectations with adjusted earnings of 23 cents per share — nine cents better than the consensus estimate, according to Thomson Financial. During the company's earnings conference call with investors, Chief Executive Steve Barnhart said he didn't see an "economic basis" for cutting service fees.

Jake Fuller, an analyst at Thomas Weisel Partners, reiterated his Overweight rating on Orbitz shares after the third-quarter report. "Concern over the sustainability of booking fees has hit Orbitz shares hard, and we see a buying opportunity," Fuller said in a research note on Nov. 14. "While the risk to booking fees is very real, fees do not look to be in immediate jeopardy.... This story may not be for the risk-adverse, but we see significant upside potential if fees can be maintained."

Even those more cautious on Orbitz see upside potential in its technology shift in Europe.

Susquehanna Financial analyst Marianne Wolk, who rates Orbitz shares at Neutral, said in a research note on Monday that there is "a tug-of-war" between the positive impacts of the technology upgrade and negative impact of Orbitz possibly having to rethink its service fees. However, "if Orbitz can sustain fees and grow closer to market rates, synergies in its international operation should mean strong acceleration in Ebitda, earnings and cash flows," Wolk said.

If the bull case pans out, chances are Orbitz will rev up growth and fuel much better returns to investors than it has so far.