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Some rough waters for Kayak IPO

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Travel search company Kayak Software filed an updated S-1 last week, implying that it will finally make its long-delayed IPO sometime this week. Kayak aims to raise as much as $100 million in a valuation that, at the high end of its pricing, would approach $965 million. The debut bears watching. A successful offering would bode well for the overall startup environment and as a proof of concept for vertical search. But Kayak also raises a few caution flags.

Kayak’s would be the first consumer Internet offering after Facebook’s, and the world wonders what it will take to take to remove that somewhat bitter aftertaste. Facebook raised $16 billion and kept tight control of the company, but priced the offering so close to demand that it failed to “pop” on opening day, and the stock has been sluggish ever since.

Kayak is something of a “traditional” consumer web play based on search, e-commerce, price transparency and consumer choice. Kayak isn’t riding any of the biggest buzz trends – cloud computing, big data or social media – and another, mobile, may be some cause for alarm. Consider:

  • Data. Kayak depends on real-time access to data about inventory, pricing, etc., but not in the unstructured formats that characterize big data analytics. The reason Kayak delayed its IPO for nearly two years was because it was fighting Google’s acquisition of ITA, the source of the bulk of Kayak’s airfare info. As part of a consent decree to enable the acquisition, Google’s ITA contract with Kayak can extend into 2016. But Google is building out its own vertical travel site.
  • Social. TripAdvisor, a bigger competitor, has built user reviews that, in fact, Kayak references, and integrates Facebook more deeply, resulting in higher engagement activity for its Facebook app than Kayak’s.
  • Mobile. Kayak says its mobile application has been downloaded 15 million times and that mobile users generated 17 percent of Kayak’s travel queries in the first quarter of 2012. But Kayak – like Facebook and Google – is a little nervous about its ability to monetize mobile activity. It estimates that mobile queries only generated 2 percent of Q1 revenue.

Hints of vertical search success

Kayak is one of the few examples of a vertical search business outside of retail. Amazon, Best Buy and others use search technology effectively on their own shopping sites, but few companies have made a go of a standalone, specialized search site. Although Kayak does enable hotel booking on its site, most of its revenue comes not from direct transactions but from bounties paid by travel sites it sends traffic to, and from advertising. Kayak had $225 million in sales in 2011, up 32 percent from $171 in 2010. It showed an operating profit of $15 million. Kayak’s growth rate increased in Q1 to 39 percent, and the company said it expected the June quarter to show revenue of about $75 to $76 million, up 31 to 34 percent from a year ago.

Those are solid if not spectacular numbers for an ageing startup in a market that’s probably already seen its big disruptions. Search engines and the first wave of online travel agencies rocked the travel industry when they exposed airline pricing and availability and put control in the hands of consumers, wiping out huge swaths of the off-line agency business. Kayak continues to fuel those online agencies, perhaps at the expense of revenue diversification. During Q1, 63 percent of its total revenue came from Kayak’s top ten travel suppliers and online travel agencies. Expedia alone accounted for 23 percent, while Priceline and Orbitz produced another 10 percent each.

So Kayak has begun to make the case that standalone vertical search can work, at least as long as it can add differentiation to the search experience through its speedy and efficient user interface. Unlike a lot of sites in the e-commerce ecosystem, Kayak doesn’t depend heavily on Google for traffic. According to its S-1a, 75 percent of Kayak’s query volume originates from people who directly visited its site or mobile apps, and only 10 percent from general search engines.

Kayak has to pay for that awareness. The company spent $58 million on brand advertising (including TV and billboards) in 2011 and a whopping $21 million in the first quarter of 2012. It expects to invest at this level or higher for the foreseeable future. And online marketing expenses – including money it spends on Google search keywords or contextual advertising – increased even faster, at over 60 percent to $18.5 million in Q1. But even with these expenses, Kayak’s margins are holding up.

Can Kayak continue to thrive in the face of general search and Google’s own vertical search efforts? Well, in 2008 Microsoft acquired Kayak competitor Farecast, and subsequently launched Bing Travel. But since 2011, Kayak has had a co-branded, revenue-sharing partnership with Bing Travel. If Kayak can continue to differentiate, maintain customer loyalty, and ride its partners, it should continue to show steady growth.

Question of the week

How can Kayak continue to differentiate in travel search?