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Amadeus: Mas Dinero Para Nos

We all have to fly, and most of us don’t like it.  It’s uncomfortable, long, inconvenient, expensive, and obnoxious to arrange.  This we can all probably agree on.  Flights from my hometown of Detroit to Philadelphia – barely a 1 hour flight – end up costing about $250-280 in the cheapest of circumstances.  Another thing we can agree on is that airlines are horrendous businesses in the long-term.  Gas costs, unionized employees, and ultra-competitive pricing from low-cost carriers push airlines to long-term losses and bankruptcies are in no way uncommon in the industry.

So I have to ask… with prices for airfare as high as they are while airlines are struggling to break even, someone out there has to be making all the money, right?

Meet Amadeus, (AMS on the Madrid Stock Exchange, or its crappy illiquid equivalent depository receipt AMADF) the worldwide leader in global distribution systems (GDS) and airline information technology (Airline IT).  This probably doesn’t mean much to you, and chances are you’ve never heard of Amadeus and don’t even know the GDS industry exists, but that’s what makes it such a fantastically overlooked business.  Before getting into why it’s worth the price of admission, a quick explanation of what the business actually does.

Amadeus is separated into 2 major business segments: Distribution and IT Solutions.  The Distribution side relates to the GDS while the IT Solutions side is – you guessed it – involved in Airline IT.  So what the hell is a GDS in the first place?  Well, here’s a quick example of how Amadeus helps you in your every-day travel arrangement.  When you go to Expedia or any other online travel agency/aggregator (OTA) and say you want to find flights from Chicago to Miami on September 21st any time before noon, Expedia comes back with dozens of hits from several different carriers and helps you find the cheapest one.  Now, you didn’t think Expedia was just that cool did you?  Well, they’re not, but the GDS is.  In this case, Expedia is using a GDS system to aggregate airline “inventories,” or seats, from hundreds of airlines to find availabilities that match your travel criteria.  I won’t bore you with the details of the technology involved in doing this, but it involves an extremely high level of data parsing, technological capacity, and relationships with airlines.  The GDS gets paid a fee by the airline every time a booking is made through its system on that airline.  Why do the airlines agree to pay this?  Well, it’s distribution/advertising for them.  If they’re not on the GDS, how are they going to get the customers to know they have the route they’re looking for?  The only way to get customers without the GDS is to have them book directly through the airline’s website via their booking tool.  This works fairly well in the United States where a very small number of carriers control most of the travel, but when customers don’t even know the airlines servicing a route – which is often the case on international and regional trips – the GDS becomes invaluable in reaching the customer.  Amadeus is the world leader in GDS bookings, with an approximately 38% market share worldwide yet only about 10% of share in North America, which means the Amadeus GDS is absolutely dominant internationally.

On the IT Solutions side, Amadeus and its competitors (which are extremely few, as I’ll explain later) help airlines operate and manage their reservation technologies and other operational/organizational tools.  The main service they provide is managing reservations, meaning the technology that keeps track of your booking after you make it, helps create a boarding pass and maintain that data in its system, and ensures that nobody else can take that seat, all while storing your information related to that flight and logging any particular requests you’ve made related to your trip.  This technology is extremely heavy, and Amadeus houses an enormous data center in France, complete with 3500 developers, that maintain this technology alongside the GDS operations.  Other services provided via the IT Solutions business are related to crew, fuel, and inventory management as well as functional services like weight and balance management, all done electronically.  The Airline IT platform provided by Amadeus is called Altea, and is currently the most popular solution, boasting a 20% market share.  Market share is measured in terms of passengers boarded (PBs), meaning the number of passengers that have been processed via the system and have actually boarded their flights.  Amadeus is paid on a per-transaction basis, charging a fee per PB to the airlines using its system.  The true beauty to the IT Solutions model is that adopting an Airline IT platform is an extremely long process depending on how big the airline is, and the process of “migrating” to a 3rd party platform like Altea is a multi-year ordeal which is typically permanent.  Airlines sign long-term agreements with Airline IT providers that usually last about 10 years and essentially bind the airline to its provider for life, as I’ll explain in better detail in a moment.  Most airlines built their own IT systems back in the 70s and even as early as the 50s, so they are currently finding themselves in need of new systems and are unable to update their own, so there has been a recent wave of airlines migrating to 3rd party platforms, a phenomenon which is expected to continue throughout the decade.

So what?  Well, to mix things up so you don’t have to read more paragraphs, I’ll go point by point and try to illustrate why the GDS/Airline IT industry is a winner and why Amadeus is the horse in this race that you want to bet on.  So let’s jump right into it before I lose your attention any more than I already have.

  • While only about 50% of bookings are made through the GDS (the rest being via airline websites), most of the bookings made directly through websites is in North America, where Amadeus correctly decides not to focus too much on.  The growth markets are mostly international, and Amadeus has steadily gained worldwide market share over its only two competitors, Sabre and Travelport, thanks to this growth.
  • Amadeus makes about EUR 3.80 per booking and is more or less guaranteed a certain percentage of air bookings since international and corporate travel will always need the services of a GDS (and most use Amadeus), so while this pricing may not and should not grow, the number of bookings should continue to grow at about a 3-4% clip as air travel continues to increase.
  • In both sides of the business, macroeconomic conditions don’t impact the business nearly as much as they do the rest of the economy.  Since revenues are both based on per-transaction/volume models, they are mainly reliant on how many people travel, and that number over time has moved proportionally to GDP growth.  People will always need air travel, whether it’s via US Airways or Delta is irrelevant, but we can confidently assume the air travel industry will still be around if we look to the future 50 years.  And Amadeus will be there with it, like it has been in the past 50 years.
  • Margins are strong on the Distribution side though growth is rather slow at about 5% topline, but margins on the IT Solutions side, which grows at a spectacular 12-15% clip, are an absolutely bogus 75%.  Not hard to see where the crown jewel and growth engine for the next 10 years is going to come from for Amadeus. And the best part is this area is almost completely unchallenged, unlike the GDS side which has competitors and the fear of more customers booking directly on airline websites, so Amadeus enjoys near monopoly power that will continue to grow as more migrations take place.
  • Once Amadeus sinks its hooks into an airline’s IT systems via its Altea platform, the airline becomes a prisoner, to put it bluntly.  With migration times for large airlines like British Airways at 2-3 years, getting out of a contract and losing your IT systems for that long would completely bankrupt any airline, so the negotiating leverage is solely on Amadeus’s end.  Within the contracts they actually have the ability to change prices per PB, and given the nature of the business it would be damn near impossible for the airline to protest these in any effective manner.
  • Given the enormous technological demands of these systems, both Distribution and IT Solutions have an extremely wide moat that keeps new competitors from entering the business.  The GDS side is an oligopoly shared by Amadeus, Sabre, and Travelport.  Sabre and Travelport are relatively poorly run and both operate mainly in North America where things aren’t so great for the GDS, so Amadeus is a near monopoly internationally.  IT Solutions is much more fragmented, and the main competitors are the airlines themselves and to a lesser extent, Sabre, who holds approximately 7% of market share compared to Amadeus’s 20%+ share.

I could continue, but I don’t want to bore you any more than I already have.  I’ve been recommending an investment in the equity traded on the actual Spanish exchange instead of the ADR equivalent which runs under ticket AMADF in the States.  The stock is currently a bit above EUR 18.00 but has potential in the near-term to break into the 20s, and we’ve been involved with the stock since the mid-15s.  Unlike some other positions I’ve recommended, this one is one of my more preferred long-term investments, as appreciation in the near-term is great but with potential to double in the next 5 years, this company is more than a quick buck.  Even at this price the market is still undervaluing Amadeus, and I suspect many of the fears tied to to the stock are not rational… like the fact that it’s a Spanish company and, to put it kindly, Spain absolutely sucks right now.  However, Amadeus does business everywhere, and the Spanish economy is a very small influence on what drives revenues in both business segments.

Anyway, I’ll add more to this later but I don’t want to overwhelm, even though I’ve been MIA pretty frequently in regards to this website.

Until next time!


A War on Social Media


I’d like to consider myself a very sensible person, often a little too much so.  I ask obvious questions to make sure I’m not misunderstanding, I make obvious statements to make sure I’m not misunderstood.  I’m no good over text message, my sarcasm is “of a rare breed” (as I’ve been told), and I will call you out on your non sequiturs.  People, by and large, are typically the exact opposite.  For that reason my market perspective (and my entire life) has most often been pretty contrarian, and my process has been dictated by tried-and-tested logical strategies.  When I look at a company whose stock I want to invest in, I’m looking for a firm that’s in an industry with solid economics that make sense for the long-term.  I need to see a company with competent management willing to make a career out of running and growing their company.  I need to be confident that 10, 20, or 50 years from today, there should still be a logical reason why this company’s product should be demanded.  And I’d definitely prefer to see them sustain margins through some sort of durable competitive advantage.

This post is mostly aimed at identifying one company where, to my knowledge, there is absolutely no durable competitive advantage, in an industry whose economics don’t logically suggest long-run success.

Social Media and the ZNGA Haterade

  The social media industry is popular, gaining momentum, and I’m using it right now.  So why hate it?  I never did until a few months ago when I was staring at my Facebook news feed and said (out loud), “what the hell is all this shit?”  I had already had friends take “a break” from Facebook – some returning and others actually enjoying their new-found freedom – and decided it was time to do the same.  I deactivated my account (i.e. deleted it) and haven’t felt the need to log back on since.  Okay, well I’m lying, I logged back on twice to watch UFC fights.  But that’s not an issue anymore, as UFC has moved on from Facebook and back to the real world: television.

I wonder… Had anyone else?

The short answer is yes.  New user growth rates for Facebook have fallen, but, given their explosive growth, this was never a surprise.  Facebook’s interface, which used to be celebrated for its simplicity and sharp image, has become cluttered with useless junk and photos from acquaintances that “friended” us sophomore year of college to make sure they weren’t too far behind the social scene.  

All this shit, I decided, had to end. 

In the long run, I don’t see Facebook making out like the next Microsoft.  There’s no computers here, no great new product, no food, and maybe not even any new technology.  For lack of a better word (since there is no better way to describe it), it’s a fad.  And being born in the 90s, I know what happens to fads.  

Any business model that relies on being “cool” to achieve success is destined to go the way of the Pet Rock.  

Unfortunately, this logical approach to evaluating Facebook’s long-run economics isn’t very helpful to us in the short run, and it’s like that Facebook will be able to do a whole lot better than companies in the same industry that are far from “top dogs” in their respective space.  Speaking of top dogs: that’s where I found Zynga.

Given my thoughts on Facebook, I went sniffing around for other social media companies that relied on being “cool,” but to a more amplified extent.  I had seen these “fad games” several times since I first joined Facebook: first there was FarmVille and Mafia Wars, then (for me, anyway) Family Feud, and most recently we have seen games like Words with Friends and DrawSomething.  The funny thing about most of these games is they’re all owned by the same company… which, conveniently enough, recently went public on the NASDAQ under the ticker ZNGA.  This was something to take a look at.

After beginning my research around the IPO date in December, I started developing an investment opinion on ZNGA.  I will try to summarize for brevity, but the following facts, with some details, helped me arrive at my decision to short the stock.

  • ZNGA primarily receives revenues through Facebook users who play their games for free.  Users can purchase “Facebook credits” from Facebook and spend them on in-game items, but the games themselves have no cost.  These Facebook-related revenues generate about 93-94% of ZNGA’s total revenues.
  • For every $1 of “Facebook credits” spent in ZNGA games, Facebook pockets 30% and ZNGA gets 70%.
  • ZNGA typically spends large amounts on Research and Development, which cost the firm 25% of revenue in 2010 and over 60% in 2011, though that was due to many employees’ stock payments being vested.  Thus, the 25% number is higher and the 60% is most likely lower.  
  • Despite spending so much in-house for game maintenance, improvement, and new game creation, ZNGA spent a whopping $210 million in total to purchase a competing game called DrawSomething.
  • DrawSomething, like any other Zynga-owned game, experienced (and is still experiencing) a quick and sharp burst in popularity.  It is unlikely that it will be able to maintain this popularity, based on what typically happens to games in the social media space, though this is simply my speculation.
  • ZNGA had 2011 revenues of about $1.1 billion, and if we simplify and assume this all came from Facebook credit purchases, results in users of its games having spent over $1.57 billion for in-game items and customization. 
  • The CEO, Mark Pincus, who I will be the first to say is a Wharton undergrad alumni, has already unloaded stock valued at 9-figures, and is in the process of dumping even more along with some other large insiders in a secondary offering of 42 million shares.  When announced, the secondary offering was at a price essentially $1 lower than ZNGA’s approximately $13.00 share price that day.  

I could go on, but I’m already worried this post will be too long for many uninterested parties to read.  So to draw these facts to a conclusion, I wanted to ask myself the following: Do people really spend $1.5 billion on little trinkets and small in-game character improvements, and who are these people?  Even if they do, how long will they continue to do that before they get bored and move on to the next thing? (see: World of Warcraft)  How much longer until there are enough competitors in this market for nobody to turn a significant profit?  

Oh, and… what about all this cashing in?  Sure, it’s great for these “entrepreneurs” to finally see their payday, and they get glorified in the media, but if they thought they had legitimate businesses on their hands worthy of holding on to, wouldn’t they be squeezing onto their shares for dear life?  And why overpay for a popular game when you can develop a competitor and already spend so much on your existing games?  Are you admitting they can do better than you?  Doesn’t sound good for the long-term to me.  Coca-Cola can get away with buying small beverage companies that are popular in niche markets because those same customers still love Coke and aren’t fully sacrificing their Coke-drinking for this niche product.  However, people tend to jump around from game to game, especially in the social media space, and games “die out” very quickly once something else becomes more popular. You don’t see anyone still playing Hangaroo, do you?  

One last point before I cut myself off: The company is currently valued at about $9 billion.  To give you an idea of what that compares to in terms of businesses one can easily see value in, it’s about 70% of the value of Chipotle Mexican Grill.  Think of it this way: if you bought out Chipotle using Facebook credits, they’d probably be willing to trade you straight up for Zynga stock.

What About Now?

We made the decision to go ahead and short ZNGA at $13.49.  Since then, there has been the announcement of the company’s secondary share offering and a bearish trend.  We have seen a string of bad days for ZNGA yet still have no plans of closing out the position.  In my eyes, there’s no reason for this stock to be worth even 50% of what the market is currently giving it credit for.  For that, we will stay short until the market recognizes the company’s true (hopefully, and in our eyes) lesser value.  

I want to echo one thing I mentioned earlier before I end.  I am bearish on social media in general and don’t see it as something that will be profitable and lasting in the way that industry staples like KO, COST, or IBM are able.  However, I think the industry has a place in our lives and will be around for a decently long stretch of time.  I aimed specifically at Zynga because I believe this to NOT be the case for them.  

Simple logic tells us that today’s Smurfberries are just tomorrow’s Sega Dreamcasts.