Description

Highlighted by the disappointing 3Q earnings announcement, Navigant International is squarely in the middle of an industry that is defined by change. Before getting into the key questions of its business strategy and challenges, its valuation and the potential catalysts for value at today’s prices, here is what they do.

Business Description:

Navigant International is second largest corporate travel management firm in North America behind American Express. A quick glance into the industry shows that companies can either handle their travel themselves – i.e. the company’s travel budget is unmanaged – or they hire an outside firm to takeover the management their corporate travel needs. The managed segment of corporate travel management firms is fragmented among many players – but the largest players are American Express, Navigant and Carlson Wagonlit. These three are the traditional old-style model firms that have a combination of on-site employees in their larger clients’ offices, have regional offices serving multiple smaller clients or have call centers dedicated to facilitating and organizing the travel needs of their corporate clients. It is fair to say they were built on a bricks and mortar platform. Specifically, Navigant has over 1000 locations in 20 countries, has over 500 offices on-site at client locations, about 120 regional offices and, in total employs, about 5000 people.

The basic valuation numbers – Navigant sells for about 9x EPS and is expected to generate about $430M in revenues in fiscal year ’04. The stock is down from a high in April ’04 of over $19 and it traded at around $18 as late as mid-October before their disappointing 3Q warning. It really caught everyone off-guard and the reasons for the 40% drop in its stock price from its recent October levels follows along with my responses and opinions. While not negating the challenges, I have strong conviction that Navigant’s stock price more than fully reflects these issues. They are not necessarily addressed in any order of seriousness.

Knock #1 -- Rapidly Changing Industry:

There have been multiple changes to their business model over time and the current environment is no different. Beyond their having to deal with the SARS outbreak and the 9/11 aftermath in recent years, their entire compensation structure has changed in the past few years. They no longer earn commissions from the airlines for booking flights for their clients. Airlines in the US and elsewhere have moved so rapidly to eliminate paid commissions that Navigant’s revenue is almost entirely borne by the client directly now. Their primary compensation now is based on a fee for service contract with the end client. Of course, there are still earn override compensation for selling a lot of volume with certain carriers, but the overall revenue shift has been large. This general industry backdrop of change hasn’t been a positive in investors’ eyes and is widely cited as a reason to dislike Navigant’s stock. Interestingly, that didn’t dampen their spirits in early October before the 3Q warning! But isn’t that the way it always works.

My Answer: Navigant has survived a very difficult past few years and have proved their value to their customers. Clients are sticking with them despite the significant change to an explicit cost arrangement. This is evidenced by their 98% client retention rate with their top 1000 clients last year. This is not a small feat in my opinion and it tells me they are doing something of real value for their clients. Also, as anyone who has been involved in arranging a business trip – it is obvious what firm’s like Navigant offer in terms of time savings and, in may cases, real bottom line savings. Travel management firms exist for a reason and while industry hiccups like SARS and the huge effect of 9/11 did have a serious impact, corporate travel management is here to stay, in my opinion.

Knock #2 -- Online Bookings and Online Competition:

Another change that is affecting Navigant, and it became even more apparent in the 3Q report, is the growing trend towards online booking in the industry. In recent months, online players like Expedia and others are trying to encroach on their smaller client turf by offering more than just travel services to the retail market. Their move to meet the needs of corporate clients has forced Navigant to answer with a cheaper online solution. The 3Q report showed about a 2% to 3% adoption rate to online bookings by some clients. This hit their bottom line due to Navigant’s very careful and rational decision to downsize people as these adoptions increase – but not before. If done too quickly, customer service will no doubt worsen – the worst outcome for any long term business. But by right-sizing on a more lagged basis did cause lower margins. They should have adjusted more quickly and they do admit that they didn’t have the proper reports to monitor the pace of the shift, but I see it as a forgivable mistake.

My Answer: After having discussed their online booking offering, management indicated that after the company adjusts its cost structure to facilitate the movement of clients to the online solution, margins could actually look better under the model. Obviously, this is based on a revenue-with-a-low incremental-cost modeling of the situation. I won’t be convinced of this until I see it, but by being responsible in their cost adjustments, I am very comforted by Navigant looking out for the service reputation with clients. Without it, they would lose the real edge than have over their disembodied online competitors like Expedia.

Knock #3 – Margin Compression:

A commonly cited reason to be negative on Navigant is their issue with the renegotiation of contracts with clients and the struggling airline industry’s attempt to lower their distribution costs by squeezing travel management companies. These are not easy issues to sweep under the rug, but at the current stock price and given the long term value proposition travel management companies like Navigant provide, I just don’t see them being priced into oblivion. In fact, these exact issues may work to bring about continued consolidation in the travel management industry and Navigant is a very possible target on many fronts.

Potential Catalyst – Takeover Target or Merger

It is not out of the realm of possibility that in a changing environment with clients negotiating pricing and airlines trying to squeeze you look to join forces with other established players. Two ways this could happen. One, American Express last year bought a travel management firm – the privately held # 4 player behind Carlson Wagonlit and Navigant. While American Express concentrates on the Fortune 1000 size firms, moving downstream into Navigant’s target mid-size firm could make some sense. On the other end of the spectrum, Expedia or another online player could be itching to get into the corporate travel segment in a legitimate way. A melding of the old traditional model with a strong online presence could make sense. In fact, if Expedia wants into the next tier of mid sized corporate customers with larger travel budgets, acquiring an established bricks and mortar partner like Navigant could be very necessary.

On a more technical note, Navigant’s stock hit a floor of about $11 per share since the warning and it has been trading above that amount for a few weeks now. While indicating nothing concrete from a fundamental standpoint, it does provide some comfort that you are no longer catching a falling knife.

It does sound too simple, but valuation does matter and with the uncertainties surrounding this industry and Navigant in particular, the market has created a stock that is very cheap. At 9x EPS, I feel confident that it will return to the upper teens on some stabilizing news in the next year. As simple as it sounds, that is likely all it will take with such a downtrodden view of their prospects.

Catalyst

Low Valuation of 9x EPS
Possible Acquisition Target
Stabilizing News