Galileo International GLC
March 24, 2001 - 6:13pm EST by
2001 2002
Price: 21.70 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 0 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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Galileo International is a great combination: a business that makes
lots of money that's selling for just 7 times earnings. The stock is easily
worth at least 16 times earnings, or more than double the current stock
price of 22.

Galileo runs a worldwide computer reservation system (CRS) for
airline tickets. When you go to a travel agent or on the Web to arrange for
a trip, Galileo or one of its three competitors provides the flight
information from the major airlines. Galileo collects a fee averaging
$8-$10 for each round trip.

The stock market has overreacted to problems Galileo has had
adapting to the Internet. The company was slow to follow the industry trend
of migration of travel away from travel agents and toward websites like
Travelocity or Expedia. The company was late in supporting online sites and
is now playing catch up. Because of this, the number of U.S. flights they
booked, a measure of unit volume, was down 7.6% in 2000 as online travel
took a greater share of industry bookings. (Offsetting this was a 4.2%
increase in non-U.S. bookings; worldwide bookings were down 0.8%.) The
company needs to attack this deficiency and has been doing so by acquiring, an online travel site, last year, and by courting other online
travel sites.

In 2000, Galileo earned $261 million before special items and
amortization, down 1% from 1999. EPS on this basis were $2.88, up 8% on
fewer shares outstanding. Revenue came in at $1.64 billion, up 8%. Bookings
numbered 347 million worldwide.

Amortization of acquisition-related intangible assets bulks large
and obscures the true earning power of the company. Amortization in the
fourth quarter of 2000, for example, was 55% of earnings before

For 2001, management expects revenues to be up 9-11% and EPS before
amortization to be up 7-9%. They say, "We are very excited about our growth
prospects in 2001 and beyond." Analysts' estimates are $3.08 for 2001 and
$3.68 for 2002. So the stock is selling for just 7 times this year's

Galileo is part of an oligopoly. It has only three competitors to
worry about. Galileo has about a 25% share of worldwide bookings. Sabre has
34%, Amadeus 28%, and Worldspan 13%.

The four companies have shown remarkably strong pricing power for
an extended period. They have raised their booking fees above inflation
every year for at least four years. As for Galileo, it raised its fee by
4-7.4% in '98, 3.4% in '99, 5.3% in '00, and 6% in '01.

Much of these booking fees are "shared", in effect, with travel
agents as "incentive fees" that flow through SG&A. There is a continuing
battle going on between airlines and travel agents, whereby airlines try to
put the screws on travel agents by cutting payments, while travel agents
seek to recoup the cuts by demanding higher incentive payments from the
CRS companies, and the CRS companies hike booking fees. The airlines will
always need the CRS companies because most consumers want a big, one-stop
marketplace for tickets. They don't want to spend hours surfing from
airline website to airline website.

Because 1) it's part of an oligopoly and 2) computer services is
intrinsically a high-margin business, Galileo is highly profitable. It may
not be hard to find stocks selling for 7 times earnings, or companies that
make lots of money, but it sure is hard to find the two elements in one
stock. Last year, Galileo needed just $720 million of tangible assets --
plant and equipment, software, and receivables -- to produce $1.6 billion
of revenue and $468 million of operating profit before amortization. This
is a return on assets of 65%, an extraordinarily high number that very few
companies can match. Most U.S. companies earn returns that are less than a
quarter of this figure.

The free cash flow is tremendous. For every $100 flowing out of the
company on an operating basis, $127 flows in. Most companies have inflow-to-
outflow ratios far lower than this, at less than 1.1x.

Debt is low and interest coverage is high, at 7 times.

Catalysts are in place. The management of the company has been
frustrated about the stock price, and their response has been the proper
one: they've bought back stock aggressively. Since the beginning of 1999,
they've bought back 22.4 million shares, or a whopping 21% of their share
base. Repurchases at deep discounts to intrinsic value are one of the most
shareholder-friendly gestures there are. Intrinsic value per share goes up
as shares outstanding goes down. It helps to have strong cash flow as
funding, of course. (There are few things more frustrating than watching
your stock go down to a very cheap price, but management can't buy back
stock because they don't have the money.)

An even bigger catalyst: Management announced, in October, that they
would explore "strategic alternatives", including a possible sale of the
company. JP Morgan was hired to advise. A buyer could borrow $5.4 billion
at 8% to buy Galileo at 9.5 times operating profits, or $47 per share. The
acquisition would be accretive because interest expense at $432 million
would be less than operating profit at $500 million.


Management has put the company up for sale; the sale price should be at
least twice the current price. Very aggressive share buybacks widen the
discount to intrinsic value, putting upward pressure on the share price.
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