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The return of the Priceline skeptic

Just a year ago, it seemed that profits were the only bona fides an Internet company needed to prove itself to Wall Street. Not so, the discount travel site has discovered.

So much for profits being the cure-all for Internet companies.

A day after Priceline.com reported a slight profit, investors punished the stock and sent it tumbling 22 percent to $4.09 Thursday.

Investors were spooked by Priceline's first-quarter earnings report Wednesday, which revealed shrinking revenue and stagnating growth at a time when other Web travel companies, such as Expedia and Hotels.com (formerly Hotel Reservations Network), are flourishing. Amid reports that the company could be a takeover target, Priceline is also facing stiffer competition from airline-backed Hotwire in its core business of discount travel.

That's not all. The company has also been pummeled as it has had to compete against the airlines while they slash prices in an effort to rally from the post-Sept. 11 travel slump. With ticket prices at rock bottom, Priceline and other discounters have fewer deals to offer customers.

On Thursday, financial advisers Merrill Lynch downgraded Priceline's stock from a "buy" rating to "neutral."

"Priceline's airline business continues to suffer from adverse conditions in the airline industry, including low airfares and reductions in capacity," said Merrill Lynch analyst Justin Baldauf.

The company hasn't seen a downturn of this magnitude since the dark days of 2000, when Priceline urgently needed an infusion of cash to stay afloat, the Better Business Bureau was breathing down its neck, and it was revealed that the company's own pitchman, actor William Shatner, had never used Priceline's service.

Just a year ago, it was widely believed that profits were the only bona fides an Internet company needed to prove itself to Wall Street. The market, for instance, rewarded Priceline last summer when the company reported its first profit, but the bar seems to have been raised, as this week's news has shown.

Priceline reported a first-quarter net profit of $3.9 million, or 2 cents a share, compared with a loss of $13.8 million, or 7 cents a share, a year earlier. But the company's revenue fell to $261.9 million from $269.7 million in the same quarter last year. The company had said in February that it expected first-quarter revenue of $260 million to $290 million.

In the company's earnings announcement, Chief Operating Officer Jeffery H. Boyd noted that the company's sales of hotel rooms skyrocketed 110 percent.

"A continued strengthening of our consumer franchise and continued expense discipline resulted in another profitable quarter for Priceline.com," Boyd said.

For Priceline, the downturn in stock price comes just as the company appeared to be skillfully managing a comeback. This month marks the one-year anniversary of a management shake-up in which Priceline replaced former Chief Executive Daniel Schulman with Richard Braddock.

Since then, the company has shed unprofitable units, begun expanding its line of products to items such as phone cards, signed a marketing partnership with auction giant eBay, and even brought back Shatner. And this time the popular actor says he's a proud Priceline shopper.

"Priceline performed well despite tough business conditions," said analyst David Kathman, of investment research firm Morningstar. "At this point, investors should be less concerned with the weak revenue."

Lagging behind
Yet it's tough to fault an investor who's comparing Priceline's flat growth to the kind of double-digit growth that other online travel sites have posted.

Last week, Expedia saw a bigger-than-expected profit for the first quarter, as revenue more than doubled from a year ago. Expedia's stock closed up about 2 percent on Thursday at $83.16. Hotels.com saw revenue growth of more than 50 percent and closed up slightly in trading Thursday, at $62.50.

So with online travel being hailed as the jewel of e-commerce, why is Priceline lagging so far behind at $5?

First, Priceline is in the discount travel sector, which is smaller than the retail travel market that Expedia, Travelocity and Orbitz compete in. And Priceline's "opaque pricing" business model, the term used to describe the practice of hiding the name of the airline and time of departure from the customer until the ticket is purchased, appeals to a much narrower segment of the traveling public.

Lorraine Sileo, an analyst with travel study group PhoCusWright, said the whole opaque market may be worth around $1.5 billion--peanuts compared with the $30 billion in sales that the whole of online travel is supposed to haul in this year.

"Because we don't publish fares, we make it possible for the airlines to accept a lower bid from a customer, knowing that the price won't be published anywhere," said Priceline spokesman Brian Ek. "This allows us to sell travel fares for less than anybody."

The Hotwire factor
Then there's a challenger to Priceline's once almost-exclusive hold on the market. Privately held Hotwire--backed by six of the top eight airlines, including American Airlines, Continental Airlines and Northwest Airlines--ignited an advertising war with Priceline this year when it began airing radio ads comparing the consumer experiences of the two services.

One of the differences between the two companies is that Hotwire reveals prices to potential customers without requiring them to purchase the fare first. Priceline requires customers to bid for fares first. Because of that, Hotwire maintains that its service is more customer-friendly.

"No bidding here; we show you the price up front," said John Hommeyer, chief marketing officer for Hotwire. "We don't force you to commit your credit card prior to seeing the price."

Yet because Hotwire doesn't share its earnings publicly, finding out its market share is difficult at best.

According to Nielsen/NetRatings, which tracks Internet traffic, Hotwire is gaining on Priceline in terms of attracting visitors.

Last December, Priceline had more than double Hotwire's traffic, but in March the gap had narrowed, with Hotwire seeing only 13 percent less traffic than Priceline. Priceline saw about 3.8 million unique visitors during the month to Hotwire's 3.3 million, according to Nielsen/NetRatings.

Sileo said that Hotwire has a long way to go before it unseats Priceline as the No. 1 discount travel site.

"Hotwire is selling itself on being customer-friendly, and Priceline is selling itself on price," she said. "But in the discount travel niche, it's all about price."

Moreover, Priceline says that more than 65 percent of its business comes from repeat customers. The obvious question there is, where is the growth going to come from?

Many analysts believe that the discount travel market is big enough for only one player, and that either Hotwire or Priceline won't survive.

"I think one of them will probably get bought," Sileo said.