So Priceline.com, which last year lost $114 million on $35 million in revenue, goes public yesterday and, in the space of one day, watches its market capitalization rocket to $9.8 billion, which means, as the New York Times pointed out, it’s more valuable than United, Continental, and Northwest combined.
There is only one possible response to this: GIVE ME A BREAK!
On the other hand, while Priceline.com is just the latest beneficiary of the Internet feeding frenzy (which is back in full effect, as a glance at AOL’s or Amazon.com’s stock chart for the past two weeks will tell you), the comparison to the actual airlines is a telling one, but not for the reasons that you might expect. After all, the airlines do the actual flying for which Priceline merely sells the tickets at a cut-rate price. The airlines own real planes, real landing slots, and established brand names. Priceline has a neat idea–though one that presumably could be duplicated by anyone–and William Shatner (the company’s ubiquitous shill). That Priceline should be more valuable than the airlines seems, therefore, absurd.
And it is absurd, because the barriers to entry in Priceline’s business are so low. (If Amazon announced tomorrow that it would be selling cheap airline tickets, would anyone be surprised?) But it’s not absurd because the airlines have real assets and Priceline doesn’t. It is the fact that the airline business is so capital-intensive that makes it such a sketchy business to be in, especially when on top of having to spend tons of money to operate you have to worry about oil prices, cyclical demand, and very little pricing power.
As many people (including Bill Gates just last week) are fond of pointing out, in its entire history the airline industry has probably created zero economic value, which is to say that its return on invested capital has never equaled the cost of that capital. So it’s not surprising that airline stocks are cheaper than, well, just about every other sector out there. If you invest in airlines, you’re investing in a business that is, almost by definition, inefficient, and that is going to put your money to less productive use than hundreds of other companies.
The odd thing is that we’re all glad that someone wants to run the airlines, and even that someone wants to invest in them (which keeps them afloat). But the experience of the airlines points up a crucial truism (much-reiterated here) about capitalism, which is that in a perfectly competitive market, there is zero economic profit to be made. As it happens, the airline industry is a long way from being perfectly competitive, mainly because the majors have a stranglehold on landing slots at the big airports. But it’s close enough, and it’s capital-intensive and cyclical enough, to erode competitive advantages very quickly. And since investors look for competitive advantage as a source of earnings growth, they sensibly have tended to avoid airline stocks (relative to other sectors).
The irony is that the Internet promises to be a market with as close to perfect competition as can be imagined, which means that most of these companies that are currently losing money are never going to get close to profitability. A business like Priceline has the great virtue of requiring almost no capital to run it, which gives it a better chance of earning a reasonable return on the capital that is invested in the business. But how it will keep competitors at bay is completely unclear. So the comparison with the airlines is a valuable one. Just not for reasons that either Priceline or the airlines would like.