Description

Summary

Investment opportunity

Amadeus is a solid business with a strong moat in the form of network effect and high switching cost trading at cheap valuation due to COVID-19. We believe long term travel will go back to normal and this presents an excellent opportunity to acquire shares in a great business. We also get long-dated options on new businesses essentially for free based on today’s share price. Trading at somewhere between 12-16x steady-state EBIT we recommend acquiring shares now and put them in the drawer for 5+ years.

Business

Amadeus is the leading IT backbone company of airline travel. The company is dominating both the air agency distribution market with approx. market share of 40% and the airline passenger service system with a market share of 50%. It is expanding into new verticals such as hospitality, payments, airport IT, and rail. The common theme for the businesses Amadeus is involved travel with a business model linked to global travel spend. It has a strong moat in its existing businesses in the form of network effect and high switching costs.

Over 90% of the revenue is recurring and contracts in the distribution business have duration of 3 to 5 years while in the airline passenger service system the duration ranges from 10 to 15 years.

Travel air agency distribution

The core business of Amadeus is the Global Distribution System (GDS) which distributes real time travel related data between buyers and sellers.

Amadeus explains this network effect well in its investor presentation, here a quote:

“Travel providers connect to the platform and provide their content to Amadeus to obtain, through a single connection, instant display of their content in travel sellers’ screens in more than 190 countries, 24 hours a day, 365 days a year. In turn, travel sellers connect to the Amadeus’ platform to access the travel providers’ content, visualise such content in an aggregated and comparable manner, search through such content and make a booking. This process is fully integrated into their workflow environment.“

The distribution business is essentially the backbone of travel IT, allowing travel providers to distribute their availability, pricing, merchandising etc to travel sellers such as Online Travel Agencies (OTA) meta-search engines, traditional travel agencies, etc.

Every time a booking is made the travel seller (airline) pays Amadeus a fee, and Amadeus again pays the travel seller a fee. With numerous Travel providers and travel sellers, Amadeus is the nexus in a strong network effect. This becomes stronger and stronger as more travel providers and sellers connect to Amadeus’ GDS.

Amadeus has gone from 26% market share back in 2000 to over 40% market share now (graph below). Although this might not be a winner takes all market in the end (it might as well be though), this high market share creates a strong moat around the company that is hard to replace. The strength of the business is also evident by the rising price per booking (average unitary fee in graphs below).

Back in 2015, Lufthansa went out and said it would no longer use Amadeus because it felt its market position had become too strong and wanted the airline industry to go together to create a new distribution system that bypassed the traditional GDS, often referred to as NDC. However, it did not take long before Lufthansa came back out with an update stating that it will continue to use Amadeus’ GDS system, and as recently as in March 2019 Amadeus and Lufthansa renewed their 30 year, yes – 30 years, GDS agreement.

Airline passenger service systems

Amadeus is also the leading provider of airline passenger service systems (PSS) with Altea and Navitaire’s New Skies. The PSS serves as the IT backbone for the airline, helping optimize revenues, brand loyalty, and reduce costs.

On the cost side Amadeus provides the airlines with tools that reduce the cost of customer acquisition, flight management modules to reduce fuel consumption, and disruption management tools to reduce the cost impact of flight disruptions.

This business is again a pay per use (like the GDS), meaning the airline pays per passenger boarded through the PSS in addition to fees for other services.

The company currently serves over 2bn bookings annually through its two systems spread over 200 customers (airlines), meaning it has over 50% market share.

New businesses

Given the high market share in the existing airline related businesses, Amadeus has for a while (started in 2012) been building new businesses. The core theme behind the business is still similar to the more mature businesses, it should be related to IT (creating a sticky recurring revenue business) and travel (core competency). Without going into details of the new businesses as we view them as long dated options, Amadeus is focusing on hospitality, airport IT, rail and travel related payments. In total the TAM for these new businesses is estimated to be 14bn EUR.

Valuation

With the shares down roughly 50% since pre-COVID, we find this an attractive opportunity to buy shares in an excellent business. This business will never trade at “cheap multiples”, but we do not believe it should given the strength of the moat, industry drivers and long term opportunities.

The EV is 24bn, 21bn mcap (45 EUR per share) and 2.8bn net debt. The low debt level gives us comfort that the company can sustain a long period of reduced travel activity.

The results of 2020 and 2021 will be materially impacted by COVID and therefore not relevant for valuation if you are a long-term investor. This is why we believe this opportunity exists.

However, if we look back to 2019, the company generated 2.2bn in EBITDA and invested around 750m in capex including intangibles (650m is intangibles). This investment spend includes a significant amount of investment in R&D for new businesses and is therefore not a good proxy for “steady state” earnings, but let us be conservative and include the entire spending. This leaves a steady state EBIT of 1.45bn EUR, meaning the business currently trades at 16x steady state earnings. We find this incredibly cheap for a business of this quality, especially considering the real multiple is probably closer to 12x given the investment in new business that is included in our EBIT estimate.

Risks

-          GDS disruption by new systems such as NDC
-          Fundamental change in travel due to COVID-19
-          High spending on new businesses that do not material into good businesses

Catalyst

COVID vaccine