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Priceline I

Professor Joshua Livnat, Ph.D., CPA

311 Tisch HallNew York University

40 W. 4th St.NY NY 10012

Tel. (212) 998-0022 Fax (212) 995-4230jlivnat@stern.nyu.edu

Web page: www.stern.nyu.edu/~jlivnat

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Priceline.com

• A reverse auction site

• The “name your price” concept can be adopted to many industries.

• B to C with a twist

• Providing travel and other services to individuals

• Commission revenues

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The Business Model• A customer makes an offer (the customer

“names a price”).– The customer agrees to lose flexibility:

• Exact departure times• Connections• A specific airline.

• The customer is bound if the offer is accepted. Credit card is charged for transaction upon fulfillment.

• Priceline matches a seller willing to sell at that price.

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The Logic• Customers obtain lower prices at the cost of

flexibility -- market segmentation.

• Sellers can sell excess capacity without eroding current markets.

• Sellers do not divulge discounts until a transaction is consummated.

• Ideal for perishable goods.

• Use customers’ power.

• Enjoy transaction fees.

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Potential Weaknesses

• Consumers with bad experiences may deter others.

• Sellers may decide to do it alone, or extract benefits (see warrant costs later).

• Others may begin similar businesses.– Patents. Actions against the patents.

• Governmental regulations may place restrictions on the business model:– mortgages.– automobile dealers.

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Facts about Priceline.com

• Began sales on April 1998 – Leisure airline tickets.

• Expanded into other areas:– Hotel rooms– Mortgages– Car rentals– New automobiles– Groceries– Through licensee - garage sales

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Facts about Priceline.com• April 1999 - IPO - sold 10 million shares for

net proceeds of $144.3 million.

• August 1999 - secondary of 1 million shares for net proceeds of $62.5 million.

• 3.8 million unique customers on 12/31/99.

• 3 million made initial purchase in 1999.

• Reasonable (at least 70% of lowest fare) offers by customers in 1999 were 57% of all offers.

• In 1999, Priceline fulfilled 43.6% of reasonable offers.

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Opportunities

• Ancillary revenues– Customers sign up for other services (credit

card, car rental, etc.)

• Exploiting other markets:– Telephone calls

• Expanding into other areas:– New/Zealand and Australia

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1999 Results

1999Revenues 482.40Cost of products 423.10Warrant costs, net 1000.30Sell&marketng 79.60General&admin 27.60System development 14.00

Operating loss 1062.20

Net operating cash flow 63.00

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Priceline.com 1999 10-K

• Unqualified audit opinion.

• Cash and s.t. investments $172 million on 12/31/99.

• Accumulated deficit of $1.18 billion.

• Revenues of $482 million.

• Product costs $423 million.

• Gross margin of about $60 million.

• Should revenues be $482 million or the commission revenues of $60 million?

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Priceline.com 1999 10-K

• Split expenses into:– Sales and marketing $80 million.– General and administrative $28 million.– Systems and business development $14 million.

• The gross margin of about $60 million is substantially less than the marketing, G&A and R&D expenses.

• The business is still consuming resources. This is typical to businesses in their initial stages.

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Priceline.com 1999 10-K

• The most significant expense is the warrant costs of $999 million !!!

• Priceline wanted to strengthen its relationships with airlines, who supply the leisure airline tickets (85% of 1999 revenues).

• It offered airlines warrants (stock options) to purchase 20 million shares at an exercise price of $52-60/share.

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Priceline.com 1999 10-K• The market value of one warrant is estimated

at $55 (consistent with stock options to employees, see Black-Scholes assumptions).

• Warrants are vested immediately. No restrictions on airlines.

• Whose expense is it? – Shareholders transfer a portion of the firm to

airlines (20 million over 164 million outstanding shares).

– Market value of Priceline (using a price of $50/share is about $8.2 billion.

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Priceline.com 1999 10-K• Options granted to employees, officers,

directors and consultants in 1999 were 6.5 million.

• No expense appears on the income statement for these options.

• Barter transactions are immaterial.

• Cash used in 1999 operations $63 million.

• Capital expenditures in 1999 $27 million, probably in excess of typical needs.

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Financial Data

Quarter REVENUES CGS G. Margin SELL&MAR G&A R&D WARRANT

Q2/98 7.0 8.0 -0.9 6.6 3.1 3.4 6.6

Q3/98 9.2 8.9 0.4 8.2 9.4 2.8 8.2

Q4/98 19.0 16.7 2.3 8.5 3.8 3.0 11.5

Q1/99 49.4 43.7 5.8 17.1 3.7 2.2 0.4

Q2/99 111.6 100.7 10.9 17.7 5.5 3.5 0.4

Q3/99 152.2 133.6 18.6 21.4 8.4 4.6 88.8

Q4/99 169.2 145.1 24.1 23.3 10.0 3.8 910.8

Q1/00 313.8 264.8 49.0 40.4 18.6 5.9 0.4

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Income Statement Ratios

Quarter G. Margin Sell&Mar G&A R&DQ2/98 -13% 94% 44% 49%Q3/98 4% 88% 102% 30%Q4/98 12% 45% 20% 16%Q1/99 12% 35% 7% 4%Q2/99 10% 16% 5% 3%Q3/99 12% 14% 6% 3%Q4/99 14% 14% 6% 2%Q1/00 16% 13% 6% 2%

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Other Unique Accounting Aspects

• Gross or net revenues– Record commission revenues or total revenues

• Are Priceline’s 1999 revenues $60 million or $480 million?

• Rebates for complementary service– 36 months Internet connection

• Shipping and handling expenses included in revenues (and selling expenses).

• Free or introductory offer is recorded as revenue and selling expense.

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Other Unique Accounting Aspects

• How is self-developed software accounted for? Over what period is it amortized?

• When can an auction site recognize revenues?– Sometimes needs to list an item for a specified

period.

• How should rewards be accounted for?– Current expenses or capitalized acquisition

costs?