Description

Overview and History - Travel Recovery Play

Sabre Corporation operates as a software technology company in the travel and hospitality industry, managing billions of dollars in annual travel spend globally. It functions largely in the Global Distribution System (GDS) market, where it connects buyers and sellers of airline seats, hotel rooms, rental cars, and a multitude of other related areas, taking a fee off the transactions. The company was most recently written up on VIC by giantfan in July of 2019, and I would highly recommend checking it out. 

A lot has changed since then, with COVID obviously having had a huge impact on all areas of the global economy, but most prominently the travel and hospitality industries. Taking this into account, this is exactly where I’ve been recently focused. I believe we’re at a turning point, while the waters were a bit too murky to see any clear and obvious investments in the space directly after the main lockdowns, there is now enough of an outlook on what direction the world is moving in as things continue to open up.

Looking at the company in specific, though, some things aren’t so different. For one, Sabre is still the second largest GDS in the world and accounts for approximately 35% of all travel agency bookings via these platforms. They also have the largest portfolio of connected hotels in North America. And second, management is focused keenly on technological improvements, business efficiency, and cost cutting just as they were pre-pandemic. They continue to stay strong in their long-term outlook and walk down the path to recovery with confidence. And since the write up in 2019, the stock is down ~66% (currently $7.88/share) with the company burning money, but expecting free cash flow to turn positive at the end of FY22. This is exactly why I believe there is an opportunity. Often seen as inferior to its larger rival and nemesis, Amadeus, Sabre has been constantly overlooked ever since it went public, and it’s no different now. 

Sabre has a few different main sources of revenue. I don’t want to spend too much time on the specifics because they can be easily found in the 10k under the business section, but they include:

1. Transactions: fees they make from travel sellers and buyers on their GDS marketplace platform. 

2. Saas and Hosted: implementation and recurring usage-based fees received for IT software on volume through the host’s (usually a hotel's) system

3. Software Licensing: revenue generated from implementation and usage of SaaS products by other parties

4. Professional Service Fees: money made from consulting and other services that help customers achieve a better return on their software investment

5. Media: revenue from customers that advertise their products and purchase preferred placement on their GDS and CRS

Industry - Details on the GDS Market

A global distribution system essentially operates as a middle man between travel agents and hotel’s and airline’s reservation systems. One positive fundamental attribute is that these sites act as intermediary marketplaces and do not hold any inventory (think of an eBay for travel agents to buy on and service providers to sell on). At the end of 2021, the GDS industry alone (Sabre’s main source of revenue) was over $6 billion, and is projected to grow at an 11.7% CAGR through 2028, to reach a total market size of $14.6 billion. Coming out of the depths of the valley of the pandemic, the industry is growing faster than it was before, which was previously in line with the growth in the amount of flying passengers around the globe of about 4-5%.

The GDS marketplace primarily serves the B2B market, with the main sellers of services being airlines, hotels, car rental brands, rail carriers, cruise lines, and tour operators. The main organizations purchasing these services are travel management companies, corporate travel departments, airports, and offline travel agencies. 

Leisure travel continues to lead the recovery, but corporate and international business travel, which is where Sabre makes the highest fees, is coming back at a faster clip now. Considering the macro situations with rising gas prices and geopolitical tension, leisure seems to have stalled a bit. But even besides this, businesses continue to spend money for travel to send employees for client meetings, project collaboration, and industry gatherings. And as it can be seen in the image below, TMC managed corporate travel worldwide is at about 60% booking volume globally compared to where it was at this point in 2019. And TMC managed domestic bookings are between 65% and 70% of 2019 booking levels.

Sabre’s top countries have also been recovering quickly, especially in North America, Latin America, and Europe. Where they have been slower, however, is in Asian countries. I believe this provides a significant opportunity as many of these countries continue to see increases in corporate spend on travel and connecting employees with each other and with clients throughout the next year. There are also some tailwinds as the governments of these countries continue to open up to foreign/international travel, seeing as their restrictions have lasted much longer than much of the Western world.

Business Fundamentals

The business is split into two main categories, where travel solutions includes the well-known and dominant GDS (marketplace) model along with some SaaS products like reservation systems, and the hospitality solutions is the smaller portion of the company that provides SaaS to over 42,000 hotel properties globally. As of 22Q2, which was released recently, the total revenue for the company continued to experience strong recovery, growing at 57% to reach $660mn, with EBIT still negative at $(70)mn but minimizing from the $(180)mn in the same period last year. Considering the continued strength in corporate and international travel, management recently raised guidance for FY22, with the middle projections estimating $2.7B to $3B in revenue. They also noted that free cash flow will turn positive at the end of the year.

Travel Solutions

• This segment represents the GDS marketplace part of Sabre’s operations along with reservation system software sales that allow end-to-end retailing, distribution, fulfillment, and increased operational effectiveness.

• Contributes about 90% of total revenue

• It is recovering with 60% growth and brought in $60mn in operating income last quarter.

Hospitality Solutions

• Represents sales from the central reservation system (CRS) and Digital Experience

• Accounts for 10% of total revenue

• Growing at 30% as of Q2 with $(12)mn EBIT for the quarter

Valuation

The company is currently producing negative free cash flow, but projecting it to turn positive in the last quarter of FY22. Not only is Sabre making it out of a tough period, but management continues to work on implementing changes they first initiated in 2018 to outsource a majority of their technology stack to Google Cloud, greatly minimizing costs and maintenance capital expenditures. This is enabling the company to have an even more attractive cost structure with (middle-range) projected 2025 FCF margins of 17.5% and EBIT margins of 25%. This is compared to pre-COVID where the company was at normalized margins of ~15% for EBIT and fluctuated between 5% and 17% for FCF. 

This will lead to free cash flow for FY2025 in the $700 million range, or ~27% yield on the current value of the equity. Considering all the debt though, the EV sits at $6.4 billion, which still denotes a 9x FCF/EV at current prices. Either way you slice it, the business would be extremely cheap if management can fulfill their promises. Strictly looking at the equity, it historically trades for a 7% yield, which would lead to 2025 equity value of $10 billion, or almost 4x the current price. Even if you take a more conservative perspective and look at it from a FCF/EV standpoint, you could assign a 15x multiple to the $700 million, then the EV in 2025 would be $10.5 billion. And considering the current capital structure, this still provides a 2.6x upside for the equity from current prices, even with only a 64% appreciation in the total EV. I assume a 15x multiple for a business operating with significant competitive advantages in a market with very high barriers to entry.

Overall, these calculations also do not assume management using any cash flow to pay down outstanding debt and deleveraging, even though they have made it clear that this is one of their priorities. This allows the valuation to still err on the side of caution without making any extraneous assumptions.

Considering management’s projections (pictured below), the company’s shift to a more profitable structure via cost cutting, and the continuous trend/rebound in the travel industry, I’m optimistic on the above valuation work.

Why is it cheap

The equity of the company currently trades at $2.6bn, with net debt of $3.8bn, denoting an enterprise value of approximately $6.4bn. It essentially comes down to the market’s trust in management and investors’ belief in the company’s ability to get their footing back and generate free cash flow soon enough for them to self-sustain, deleverage, and stabilize growth. Overall, this doesn’t require in-depth number crunching and elite Excel skills. It’s simply an unpopular belief and perspective to the rest of the market. It’s a belief in the global travel industry, and although corporate travel may be fundamentally different post-pandemic, it’s still an integral part of the economy. Signs are pointing to a recovery of the industry by 2025 in-line with levels similar to those last seen in 2019. Based on outlooks from other companies such as Visa, Mastercard, AmEx, and Hyatt Hotels, the entire industry is showing continued resilience.

I also believe that the market is mistakenly mixing outlook on leisure and business travel. With gas prices still relatively very high and consumers getting increasingly cautious about traveling, many forget that this area of the travel market does not have an outsized effect on a company such as Sabre.

Competition and Market Dynamics

The GDS market acts very similar to an oligopoly, with the top 3 companies (Sabre, Amadeus, and Travelport) taking up a cumulative of about 80% market share.

Because of the boring nature of the business and the way that the stock is trading, I originally viewed the investment as a cigar butt type of situation. But the more I learn about Sabre as a business, the more I realize that they really are in quite a favorable competitive position. Two main factors are most prominent to me, with one being their advantage as a platform and the other materializing as the network effects that stem from this platform. 

• Platform: First of all, the GDS acts a toll road for any large organizations or groups looking to sell and purchase travel related solutions. It is a prime location for hotels and airlines to advertise and reach sticky, higher volume customers without having to spend a large amount of incremental dollars. Also, considering that the company is migrating a large portion of its software capabilities to the cloud, it eliminates the immense fixed costs associated with installing and maintaining the necessary servers/hardware for the system.

• Network Effects: With any software marketplace (or really any marketplace in general) you almost always experience the network effect flywheel. It essentially relates to the fact that, as more buyers enter the system, more sellers also join to reach these buyers, and with more sellers/products, this then causes even more buyers to join, and so on.

Sabre is extremely entrenched in the US travel market, while their main competitor, Amadeus, is most prominent in Europe and doesn’t have enough infrastructure in place to take control of the US. The industry has consolidated and the top 3 players are happy to hold their market share and maintain their share of profits without trying to spend an absurd amount of incremental dollars for a few basis points of market share and an abysmal ROIC. 

Debt and Liquidity

• The average cost of debt was at 5.46% as of FY2021. One of the main positives here is that the business seems to have very solid relationships with lenders, where they were able to push back any maturity dates from before 2024 to 2025 and beyond

• $256mn of debt due within the 2022 calendar year

• $1bn of cash and equivalents on the balance sheet as of the most recent quarter

Risks

• Travel industry growth stalling, specifically in corporate spending and international travel

• Increased geopolitical tension, including US and China relationships and ongoing war in Ukraine

• Inflation, CPI data today was positive but still much higher than average historic numbers

Catalyst

Continued recovery of the travel industry

Management's continued success in cost-cutting via migration of tech stack to the Google Cloud