Sabre Stays Sharp

We expect

Among the top three operators, we see the company’s share of GDS bookings reaching 35.4% over the next few years, up from 35.1% in 2016. We expect Sabre’s technology share of passenger boardings to rise to 23.5% in 2026 from 21.4% in 2016.

Sabre’s GDS enjoys a powerful network advantage. As more supplier content (predominantly from airlines) is added, more travel agents use the platform, and as more travel agents use the platform, suppliers offer more content. This network advantage is solidified by technology that integrates GDS content with back-office operations of agents and IT solutions of suppliers, leading to more accurate information that is also easier to book and service the end customer with.

The company’s platform reach should expand as Sabre looks to grow in European and Middle Eastern countries where it previously had only minimal penetration, which are also markets that yield higher than the consolidated North American region. Finally, over the long term, the Abacus acquisition should aid Sabre’s presence in Asia-Pacific, where Abacus’ share was 39% in 2014.

Replicating Sabre’s GDS platform would entail aggregating and connecting content from several hundred airlines to a platform that is also connected to travel agents, which requires significant costs and time. As a result of these barriers, three operators--Sabre, Amadeus AMS, and Travelport TVPT--control nearly 100% of the GDS market, and we think they enjoy efficient scale, which is evident in the limited traction that airlines or travel agents have had in bypassing this distribution platform.

The main risk to Sabre and the GDS industry is technology advancements that increase the ease of booking travel directly through supplier websites (disintermediation) or through direct connections between suppliers and online travel agent platforms, which bypass traditional travel agents using the GDS platform.

Network Effect Drives Narrow Moat Sabre has a narrow moat driven predominantly by a network effect in its core global distribution system business (70% of 2016 revenue). This network advantage is strengthened by the continued expansion into IT solution markets (30% of 2016 revenue), which serves to further integrate the connection that supplier and travel agent customers have with the company's GDS platform. The IT solutions business provides a secondary switching cost advantage, as contract lengths are three to seven years, implementation takes one to two years with high costs, and renewal rates are comfortably above 90%. The core distribution business also exhibits an efficient scale moat because three players control the entire market, and high technology costs are needed to replicate GDS networks in what we believe is a business with returns on invested capital in the low to mid-teens.

The company holds a network advantage, as its GDS hosts content from all global airlines (which pay Sabre a booking fee), and this scale of content attracts use by both traditional and online travel agents, as well as travel management companies, which receive incentive fees from Sabre to book on its GDS. This in turn encourages airlines to provide more inventory to the platform. The company’s technology also integrates efficiently with supplier and travel agent back-office operations, strengthening the overall network advantage. Sabre held a mid-30s share of the GDS market in 2016 among the top three players.

We also believe the core distribution business holds efficient scale advantage. Sabre, Amadeus, and Travelport combined control nearly 100% of the GDS market, which signals that an efficient scale barrier exists. All airlines use the GDS distribution channel and are increasingly connected to these platforms through back-office technology integration that makes information on the platform more accurate and accessible. Additionally, all travel agents (both traditional and online) source airline content through a GDS and are also increasingly connected to the platform through back-office technology integration that makes planning, booking, and servicing clients easier. Finally, replicating an existing GDS would require large costs to aggregate and process content and then efficiently integrate that content with both travel agents and suppliers for what we believe amounts to a midteens ROIC opportunity at full scale. These costs are recurring, as each year Sabre spends a high-single-digit percentage of revenue on capital expenditures ($328 million in 2016), a portion of which goes toward improving its distribution technology (search, processing, integration, inventory management, new products) and IT solutions offering (data analytics, commercialization).

The mixed success the airline industry has had in bypassing or replicating a GDS supports the efficient scale and network advantage in Sabre’s distribution business. To start, any airline flight is either booked on a carrier website (direct) or through traditional travel agents, travel management companies, and online travel agents, which all use a GDS (indirect). Over the past several years, technology advancements have helped airlines drive booking traffic away from GDS users and toward carrier websites. That said, this disintermediation pressure might be stabilizing as a result of improved GDS costs and technology; also, carriers have penetrated their direct domestic bookings and may now need to tap into the GDS’ global scale for foreign and corporate bookings.

While airlines have had some success with direct bookings, their success in evading the GDS for indirect booking channels has been very limited. All airlines connect to traditional travel agents’ and travel management companies’ traffic through a GDS, and most all airlines also use this distribution channel to link to online travel agents’ demand. It is costly and time-consuming for an airline to connect to individual agents, and it is inefficient for these agents to use one-off connections versus the aggregated content of the GDS network. As a result, all airlines continue to use the GDS distribution channel to access agent traffic. Additionally, Sabre is increasingly providing technology to airlines for all direct and indirect bookings, whether on the GDS or on carrier websites, resulting in a solid ongoing presence in the booking channel.

Lufthansa and International Airlines Group have instituted surcharges in select regions where they are dominant (Germany for Lufthansa and the United Kingdom for British Airways). However, surcharges are removed for select agents that drive high volume for these carriers in these regions. Through these private channels, GDS networks continue to facilitate inventory and order management, and it is our understanding that the economics for Sabre and other distribution operators are little changed in these private deals. The continued use of GDS networks in private-channel relationships supports the network effect and efficient scale advantages that we award Sabre and others in the industry.

GDS distribution costs for airlines are typically only a low-single-digit percentage of total airline costs, and given the reach that major GDS platforms provide, the channel will continue to make strategic sense for suppliers, in our opinion. Additionally, processing costs continue to increase, as more searching is occurring before booking, which further supports the efficient scale advantages of Sabre and others in the industry.

Sabre also has a leading presence in IT solutions for airlines, which enhances the network advantage in its distribution business; the IT provided to suppliers is integrated with the GDS platform, leading to improved accuracy and efficiency of supplier content. We estimate that Sabre has a low 20s share of the airline IT market, based on 789 million of the world’s 3,696 million passengers boarded who crossed over the company’s technology solutions in 2016. Sabre also holds a leading position in the hotel IT industry, driven by key partner Wyndham Worldwide. Switching costs are high in the IT segment because of elongated sales cycles, implementation times (12-24 months), and contracts that are three to seven years in length with retention that is comfortably above 90%.

Our narrow moat rating is further supported by returns on invested capital that we expect to average in the midteens the next several years, comfortably above the company’s 7.6% cost of capital.

Cyclicality and Disintermediation Are Risks The travel industry is cyclical and affected by changes in economic growth. In a downturn, consumers have less income and look to cut back on discretionary expenses like leisure travel. Sabre is not immune here, although its transaction-based model, which is tied to volume versus airline, car, or hotel prices, allows for lower volatility resulting from cyclical pressures. While Sabre's financial information during the 2008 recession is not available, key peer Amadeus, which has a similar model for its distribution business, had revenue declines of only 2.8% and 4.8% in 2008 and 2009, respectively.

Airlines continue to look for ways to migrate bookings directly to their websites, as costs are often lower than indirect distribution platforms like Sabre’s global distribution system and also allow for more control of the customer relationship. Airlines may look to bypass a GDS network by connecting their content directly to online travel agencies, in order to save on booking fees.

Sabre has large exposure to the U.S. (40% of total revenue). Any economic weakness in this region would probably have a negative impact on the company’s financials. We assume U.S. corporate tax reform will benefit Sabre starting in 2018; deviation from our targets could lead performance to stray from our valuation.