Sabre's Network Advantage Intact Despite a Challenging Near-Term Environment

Although narrow-moat Sabre’s booking share reached 37.3% in the third quarter versus 37.1% in the prior year, the company experienced top-line and bottom-line near-term headwinds. The travel segment saw sales growth of 2.3% versus the prior year and 24.4% growth on a two-year stacked basis, which decelerated a bit from last quarter’s 27.9% growth rate. The slowdown was due to U.S. corporate weakness (U.S. is around 40% of company sales) and the insolvency of a large customer in Europe. Encouragingly, these issues appear transitory, as management has seen a pick-up in multinational travel during October and expects fourth-quarter revenue reacceleration to 4%-5% growth (27% on a two-year stacked), resulting in 2016 sales growth just over 12%, which is below our existing 2016 forecast of 13.5% growth. As a result, we plan to reduce our sales forecast toward 12% for the year, while maintaining our 4% annual long-term growth forecast.

Due to U.S. corporate weakness, North American booking growth was an anemic 1.6%, but Sabre expects improvement here in the fourth quarter. Meanwhile, the Europe, Middle East, and Africa region saw bookings growth up 3% (adjusted for an insolvent customer) in line with the market, and Sabre expects share gains in the region to resume in the fourth quarter as new customers come online. Finally, Asia-Pacific bookings growth was up a healthy 6.8%, aided by Abacus, which was acquired in the middle of last year.

We expect Sabre's global distribution system share to increase over the next several years, driven by expansion into new markets, the recent acquisition of Asian Pacific GDS company Abacus, and a growing presence in technology solutions for travel suppliers and agents. We see the company's share of GDS bookings (among the top three operators) reaching the mid-30s at the end of this decade from low-30s in 2015. We see Sabre's technology share of passenger boardings reaching the high-20s in 2020 from a high-teens percentage in 2014.

Sabre's GDS enjoys a powerful network advantage. As more supplier content (predominantly airline content) 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 the GDS with back-office operations of suppliers and agents, leading to more accurate information that is also easier to book and service the end customer with. Additionally, the company's platform reach should expand as Sabre looks to grow in European and Middle Eastern countries where it had previously only minimally penetrated. Finally, the recent Abacus acquisition will greatly expand Sabre's presence in Asia Pacific (Abacus' share was 39% in 2014).

Replicating the company'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, and Travelport--control 98% 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.

Sabre has a narrow moat predominantly driven by a network effect in its core global distribution system business (70% of 2015 revenue). This network advantage is strengthened by the continued expansion into IT solution markets (30% of 2015 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 five to 10 years, implementation takes over a year 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 mid-teens.

The company holds a network advantage, as its GDS hosts content from most all global airlines (which pay Sabre a booking fee), and this scale of content attracts use by both traditional and online travel agents (which receive incentive fees from Sabre to book on its GDS), which 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 low-30s share of the GDS market in 2015.

We also believe the core distribution business holds efficient scale advantage. Sabre, Amadeus, and Travelport combined control 98% 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 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 percent of revenue on capital expenditures ($287 million in 2015), a portion of which goes toward improving its distribution technology (search, processing, integration, inventory management, new products).