Description

Overview

I believe Sabre Corporation stock (SABR) at current prices ($19.63) is a compelling long with 30- 50% upside over the next twelve to eighteen months. SABR offers critical technology solutions to the airline and hospitality industries. SABR is a high quality business with a long operating history, but it has only been public since April 2014. I believe SABR is a relatively misunderstood business and stock. Investors are generally not familiar with SABR’s business model and value proposition. There is not much consistency in sell side coverage. SABR is generally covered by technology analysts but also airline and hospitality analysts. The company’s financials have been partially obscured by non-core assets like the Travelocity and lastminute.com. In addition, SABR’s two key businesses have very different growth rates, margin profiles and industry structures. SABR’s shares should re-rate higher as investors become more familiar with the business and begin to recognize the free cash flow generation. The private equity overhang should also subside in the next few years.

Brief History

Sabre has a long history as a business but a relatively short history as a public company. The business started as a passenger reservation system within American Airlines in the 1960s. The technology offering was further developed over the next few decades and American did a partial initial public offering of the company in 1996. SABR was fully spun off in 2000. Texas Pacific Group and Silver Lake acquired the company in 2007. SABR reemerged as a public company in April 2014. TPG and Silver Lake did not sell shares in the offering. Proceeds were used to deleverage. The offering was priced at $16. This was below the range of $18 to $20.

Business and Industry

Sabre’s two core businesses are Travel Network and Airline-Hospitality Solutions. The Travel Network business is one of three dominant global distribution systems (GDSs) in the world with 36% share of GDS-processed air bookings. This is a mature business growing in the low-to-mid single digits with low 40% EBITDA margins and minimal capital expenditure requirements. Capex is 2% to 4% of revenue. It is an attractive industry with high barriers to entry, high switching costs and stable market shares. The Airline and Hospitality Solutions business is a growing software as a service (SaaS) business. Management is targeting 12% to 14% annual revenue growth given the long runway and outsourcing opportunity. Sabre offers SaaS solutions to airline and hospitality customers for critical operating systems, such as, reservations, revenue management, crew scheduling and flight operations. These systems were traditionally managed in-house by customers and are now in the early innings of being outsourced as companies prefer the flexibility of a more variable cost base. Customers pay SABR on a per transaction basis and obviate the need for significant upfront investment. Sabre has a third reporting segment for its Travelocity business. Travelocity has been weighing on SABR’s overall growth and profitability and is being restructured in an arrangement with Expedia. Sabre might exit this business entirely in the next year or two and focus on its two core businesses.

Travel Network

Global distribution systems sit between travel suppliers such as airlines and travel buyers such as travel agencies. SABR distributes travel content from approximately 125,000 travel suppliers to approximately 400,000 online and offline travel buyers. The GDS market is dominated by three players: Amadeus, Sabre and Travelport. Each has approximately one third market share, but shares vary based on geography. SABR has around 55% market share in North America while Amadeus has around 63% market share in EMEA. GDSs earn revenue on a fee per booking basis and enable airlines to cost effectively manage and distribute inventory. The booking fee is a flat fee and negotiated with each airline. It is typically 2% of the value of the booking or $4 to $5 per booking. This varies based on region. The GDS shares a percentage of the booking fee with the travel agency as a revenue share or incentive. SABR’s Travel Network revenue is driven by passenger volume, the booking fee and its market share. It’s a very sticky business with customer retention rates in the 99% range. IATA estimates there were approximately 3.3 bn airline passengers in 2014. Enplanements have grown at a 4% to 5% CAGR over the last 20 years. IATA, Boeing and others expect passenger growth to be in this range for the next several years driven by developing markets. Industry estimates point to approximately 50% of passenger volume being distributed over GDSs. The remaining volume is mostly distributed through the airlines’ websites. This is referred to as direct distribution. Direct distribution was around 35% of bookings 10 to 15 years ago but has increased to around 50% due to the proliferation of e-commerce platforms. This migration from indirect to direct has created a modest headwind for the GDS industry over the last several years. However, based on industry checks, the share shift has slowed or even stabilized. In addition, several low cost carriers, such as Ryanair, easyJet and JetBlue, have recently moved to distribute on GDSs to improve ticket yields. Most business and first class travelers book through travel agencies such as American Express and Carlson Wagonlit Travel. These bookings typically offer average ticket yields 10% to 20% higher than direct bookings for airlines. The higher yields more than offset the booking fee. Here are two comments by JetBlue highlighting its usage of the GDSs to reach the most profitable segment of the travel market:

“Our participation in global distribution systems (GDSs) supports our profitable growth, particularly in the business market. We find business customers are more likely to book through a travel agency or a booking product which rely on a GDS platform. Although the cost of sales through this channel is higher than through our website, the average fare purchased through the GDSs is generally higher and often covers the increased distribution costs.” – JBLU 2013 10K

“Our re-entry into GDSs in 2007 has supported our growth in the corporate market, as business customers are more likely to book through a GDS, and while the cost of sales through this channel is higher than through our website, the average fare purchased via this channel is at least 17% higher, justifying the increased distribution costs.” – JBLU 2008 10K

Ryanair and easyJet have made similar comments.

“So, the volumes in our overall would be relatively small, but they will be significantly higher yielding and the average fares, being paid by those passengers, will more than cover the GDS cost.” – RYA ID conference call, 5/19/14

“GDS availability will significantly widen Ryanair's distribution and give us an entry into or make us much more visible to corporate travel agents and the larger business houses, particularly as we expand our services into a number of major airports over this year.” – RYA ID conference call, 2/3/14

McKinsey did a return on capital analysis for IATA in 2013 (CRS = computer reservation system services provided by the GDSs):

Airline and Hospitality Solutions

The Solutions segment is the growth business for SABR. The business had revenue of $760 mm over the last 12 months. This compares to around $520 mm in 2011. Revenue grew at a 17% CAGR between 2011 and 2013. The company offers solutions to the airline and hospitality industries. The biggest of which is the reservation system. The SabreSonic reservation system comprised around 55% of Airline Solutions revenue in 2013. SabreSonic is a fully integrated suite to help airlines manage reservations, marketing and planning, and enterprise solutions. This is a sticky business with long lead times (often more than a year). Sabre earns revenue on a per transaction basis (per passenger boarded (PB)). SABR had 478 mm passengers boarded in 2013 and earned around $0.70 of revenue per passenger boarded. Based on industry checks, there is a good opportunity to cross sell airline customers on additional services. SABR estimates 35% of its airline customers use 1-2 solutions, 36% use 3-5 solutions and 29% use 6+ solutions. SABR is #2 in the passenger reservation systems market with 18% share of airline PBs. SABR competes with Amadeus, Navitaire, Jeppesen, Lufthansa Systems and others. Amadeus is #1. The top three players control around 50% of the market based on PBs. The opportunity in hospitality solutions is in the earlier innings. Sabre offers SaaS products related to reservations, business intelligence and property management. This is a $100 mm revenue business but growing rapidly. Sabre competes with MICROS Systems, TravelClick, Pegasus and others.

Relevant Primary Comments

easyJet business development executive:

“The company is looking for the high yield business passengers now. This was not the case early on. These passengers are being booked through the GDSs.”

30 year industry executive:

“The bookings that haven’t moved online (direct) are very valuable. This is mostly corporate travel like Amex and Carlson. These short notice, multi-segment, business tickets are not likely to move online as easily as leisure.”

Investment bank corporate travel department:

“We have built (reporting) technology on top of Sabre’s booking engine. This makes switching challenging.”

Etihad Airways business development executive:

“Feedback from some airlines is that it costs more to do direct distribution than use GDSs for access to agencies. Airlines are not actively pushing for direct now. They used to push for this option much more. It’s expensive to host your own infrastructure platform.”

“Sabre provides everything you need to run the airline efficiently. Their systems integrate easily. This is the big attraction. Their solutions help reduce an airline operating cost.”

United Airlines distribution strategy:

“Travel agencies are highly dependent on the GDSs. It’s an entrenched service. The GDSs have all the data and information that travel agencies need. They also power the backend reporting and tools.”

Carlson Wagonlit executive and regional jet COO:

“The GDSs have found ways to create value for both travel agencies and travel suppliers. GDS and Sabre solutions help airlines with all these ancillary revenues. These providers can build it once and sell it to multiple airlines. Airlines don’t want to develop it themselves due to cost.”

Valuation and Financials

SABR reports three business segments: Travel Network, Airlines and Hospitality Solutions and Travelocity. Travelocity is undergoing a restructuring with Expedia and is obscuring the growth and profitability of the Travel Network and Airlines-Hospitality Solutions businesses. For example, Travelocity earned an 18% EBITDA margin in Q32014 and a 4% EBITDA margin in 2013. Travel Network and Airline-Hospitality Solutions earned a 42% and 30% EBITDA margin in 2013, respectively. In addition, Travelocity’s revenue has been declining year over year. SABR’s management has decided to focus on its two core segments and is reducing its exposure to Travelocity through a strategic marketing agreement with Expedia. It is also possible that SABR exits this business entirely over time. The company has been divesting non-core assets with lastminute.com being the most recent. The restructuring has created a temporary working capital drag on free cash flow as Travelocity is no longer the merchant of record for transactions. Going forward, SABR will collect a marketing fee from Expedia based on the amount of travel booked. I believe the company’s focus on its two core segments makes sense and will make the company easier to analyze. Management is targeting 4% to 6% revenue growth for Travel Network and 12% to 14% revenue growth for Airline and Hospitality Solutions. Travel Network EBITDA margins should remain in the low-40% range where they have been for years while the Solutions business should experience margin expansion given increasing scale. Management is targeting “high 30%” EBITDA margins for the Solutions segment over time compared to 30% in 2013. I think the company, excluding Travelocity, will earn around $1.60 FCF per share in 2017. This is a fully taxed number. Travelocity could be worth another $1 per share. Amadeus (AMS SM) is valued at 23x free cash flow. I don’t think SABR should trade at this valuation, but I think that 12x FCF is probably too low for an asset light business with a dominant competitive position, strong cash generation, high return on capital, and mid to high single digit top line growth. As the company executes on its plan, and de-levers its balance sheet through internally generated cash, I think stock will rerate to a 15-18x FCF multiple, in line with similar businesses. It is also worth noting the CEO, Tom Klein, owns around 2 mm shares or approximately $40 mm of stock. Private equity still owns around 80% of the shares. This will remain an overhang but the shares could respond favorably over time to improved liquidity from secondary offerings.

Risks

Passenger travel: global passenger travel is tied to GDP growth. A recession or health scare would reduce demand.

Leverage: SABR is levered 3.6x net debt/LTM EBITDA.

Disintermediation: this has been an ongoing risk. If direct continues to grow at the expense of indirect, it would be a continued headwind.

Limited float: private equity still owns around 80% of shares.

Catalyst

Travelocity announcement.

Solutions business contract wins.

Travel Network air bookings performance.