Amadeus: An Aggregation Platform and IT Business That Will Grow Along with Airline Passenger Volumes
Member write-up by Philip Hutchinson
Amadeus is a large, Spanish-headquartered IT company serving customers in the travel industry, tied to the long-term growth of transactions in the global travel industry.
First, let’s talk a bit about what the company does. Although all of Amadeus’ activities relate to the travel industry, the company is in effect two completely separate businesses: the operation of a global distribution system (“GDS”) and the provision of software to companies in the travel industry – mainly airlines.
Amadeus was founded in the 1980s as a partnership between four European airlines: Air France, Iberia, Lufthansa and SAS. (At this stage, it was only the GDS side of the business – the software business came later.) A GDS is, essentially, an aggregation platform sitting between users of travel services – principally travel agents – and providers of travel services, such as airlines, hotels, train operators, and the like. So, it is a two-sided marketplace, aggregating both supply – the inventory of flights, hotel rooms and so on – and demand – travel agents and other travel intermediaries (for example, corporate self-booking platforms). The Amadeus GDS, like other GDSs, is a transaction-driven business model, principally earning fees when reservations are placed. Fees are also earned for services provided to travel agents.
Some years later, in the early 2000s, Amadeus launched what has become its IT business. This business is the provision of software to airlines to manage various aspects of their operations – from customer search and booking, through to ticketing, reservation, check-in, baggage, and weight management of the aircraft. Similar to the GDS, Amadeus operates a transaction driven business model, charging its airline customers fees on a per passenger boarded basis.
I mentioned that Amadeus was initially founded as a partnership between four European airlines. In 1999, the company was listed, only to be the subject of an LBO by Cinven and BC Partners (with three airlines – Air France, Iberia and Lufthansa – also taking stakes). The company was subsequently re-floated in 2010 following a successful period of private ownership and has remained public since then.
Given that Amadeus has two very distinct businesses, it makes sense to address these in turn.
First, though, I set out some financial information for the business from 2007 – 2017 which should give you some context as I discuss its principal operations. All figures (other than percentages) are in millions of Euros.
| 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | |
| Revenue | 2,578 | 2,505 | 2,461 | 2,593 | 2,759 | 2,910 | 3,104 | 3,418 | 3,912 | 4,473 | 4,853 |
| Gross profit | 1,908 | 1,878 | 1,869 | 1,940 | 2,081 | 2,163 | 2,300 | 2,538 | 2,868 | 3,323 | 3,562 |
| Operating profit | 468 | 467 | 549 | 312 | 831 | 833 | 888 | 956 | 1,053 | 1,212 | 1,323 |
| Pretax profit | 218 | 237 | 372 | 66 | 668 | 721 | 824 | 898 | 1,004 | 1,144 | 1,263 |
| Cash from operations | 890 | 785 | 836 | 700 | 980 | 991 | 1,023 | 1,087 | 1,273 | 1,493 | 1,557 |
| Interest | -197 | -416 | -140 | -134 | -168 | -165 | -57 | -58 | -53 | -65 | -23 |
| Capex | -183 | -190 | -189 | -261 | -312 | -349 | -411 | -427 | -550 | -595 | -612 |
| Free cash flow | 510 | 179 | 507 | 305 | 500 | 477 | 555 | 602 | 670 | 833 | 922 |
| Total assets | 5,528 | 5,505 | 5,562 | 5,331 | 5,044 | 5,155 | 5,427 | 6,165 | 7,004 | 7,774 | 7,883 |
| Current liabilities | 1,040 | 1,018 | 1,020 | 1,038 | 1,018 | 1,212 | 1,213 | 1,663 | 2,199 | 2,308 | 2,284 |
| Gross margin | 74.01% | 74.97% | 75.94% | 74.82% | 75.43% | 74.33% | 74.10% | 74.25% | 73.31% | 74.29% | 73.40% |
| Operating margin | 18.15% | 18.64% | 22.31% | 12.03% | 30.12% | 28.63% | 28.61% | 27.97% | 26.92% | 27.10% | 27.26% |
| FCF margin | 19.78% | 7.15% | 20.60% | 11.76% | 18.12% | 16.39% | 17.88% | 17.61% | 17.13% | 18.62% | 19.00% |
| Return on assets | 8.47% | 8.48% | 9.87% | 5.85% | 16.48% | 16.16% | 16.36% | 15.51% | 15.03% | 15.59% | 16.78% |
| Return on capital | 10.43% | 10.41% | 12.09% | 7.27% | 20.64% | 21.13% | 21.07% | 21.24% | 21.91% | 22.17% | 23.63% |
| Cash return on capital | 11.36% | 3.99% | 11.16% | 7.10% | 12.42% | 12.10% | 13.17% | 13.37% | 13.94% | 15.24% | 16.47% |
The GDS business
As explained above, a GDS is a classic two-sided platform aggregating a disparate group of travel providers with a disparate group of travel users / resellers. To be valuable, such a platform has to have a large number of sellers, and a large number of buyers. Unsurprisingly, therefore, the GDS market is concentrated, with market share being both concentrated and relatively stable. The top three GDS providers (Amadeus, Travelport and Sabre) account for over 90% of the market, and within that, Amadeus is the clear leader and, what is more, has been able to grow that lead (although it is not the market leader in every geography – as a European business founded by European airlines, it has a much stronger position in Europe than it does in North America). In the 2010 IPO prospectus, Amadeus estimated its market share at 37%, with its closest competitor, Sabre, at 30%. By 2016, Amadeus’ share was around 42%, with Sabre at around 34%. It appears that Amadeus’ market share gains have come at the expense of Travelport. This is the continuation of a trend of market share gain that had already been going on for some years.
The fee models of the GDS platforms are very attractive. Basically, they don’t charge content providers (that is, airlines, hotel owners, etc.) for supplying them with inventory. Instead, they charge a fee per booking. That fee does not, I believe, depend on travel industry pricing. So, although Amadeus is exposed to global travel volumes, it is not sensitive to the actual pricing of flights, hotels, etc. This is important because it means that Amadeus is not affected by cyclicality in airline pricing. It is only affected by an actual drop in the number of bookings made on its platform. So, although airlines have traditionally been quite a cyclical industry, Amadeus itself is much less so. You can see this in its financial results. The numbers presented above include Amadeus’ performance in the financial crisis. Of course, as customers cut down on travel, its business suffered. But its per-transaction pricing meant that, unlike an airline, it did not suffer the double whammy of both lower volumes and lower prices.
So, the GDS is clearly a good business and its financial performance reflects this. The GDS segment contribution to Amadeus’ results is consistently at over 40% operating margin (for example, in 2016, Amadeus’ GDS earned €1,223m on revenues of €2,925m).
It’s also a growing business. GDS revenues have grown from €1,937m in 2007 to €2,925m in 2016 – a 4.7% compound rate. And, that punishes Amadeus by selecting a starting point just prior to the financial crash. Overall, it seems entirely reasonable that the GDS revenues – and hence profits – should grow at around the rate of global growth in travel.
However, there are some risks. The most obvious of these is disintermediation. Basically – the airlines don’t like giving Amadeus (or the other GDS providers) their inventory for free and losing revenue to Amadeus on every ticket booked through the GDS. They would prefer to sell their seats direct to consumers where there is no intermediary taking a cut of the ticket price. And one of the ways that the airlines are trying to disincentivise the use of GDSs is to charge more for flights on the GDS than for flights booked directly.
Another risk comes from the other side of the platform. The rise of large online travel agents means that, on the buyer side of the platform, GDS providers are increasingly negotiating with larger customers in a less fragmented market. This gives rise to the risk that GDS providers’ advantage in bargaining power over a fragmented customer base starts to reduce. And also raises the possibility of airlines providing inventory directly to those large travel agents. I have not seen any tangible evidence of this and I think the incentive for travel agents to negotiate hard on the GDS booking fee is not particularly obvious. But, I could be wrong here and it is certainly something to keep an eye on.
Having said that – there are a number of factors in play that mean that, in my view, these risks may not be fatal to Amadeus.
First, two-sided platforms such as GDS have clear returns to scale and network effects benefiting the largest incumbents. It’s not surprising, in this context, that Amadeus was founded by an alliance of airlines who could give it an immediate source of content. (This was also true of Sabre, which was founded by American Airlines.) The task facing any new entrant to the market would be absolutely formidable. It’s very hard to see that a new entrant could get either enough inventory, or sufficient travel agent customers, to be viable unless it was formed as some sort of partnership between either large travel agents or (more likely) large airlines. That was, of course, exactly how Amadeus and Sabre were formed. And then – how likely is that? Particularly in the context of the large airlines trying to promote their own direct distribution channels. So, the risk of a new entrant is very, very low.
Secondly, the airlines have wanted to disintermediate for some time. But the reality of doing that is quite difficult and there are also trends in the opposite direction. For example, low cost airlines such as Ryanair resisted using GDSs and generally favour direct distribution – but they have ended up agreeing to provide their flights to GDSs. GDSs become increasingly important to airlines as they grow and also provide access to a segment of travellers (basically, higher yielding business customers) that are harder to reach via direct distribution.
When you think about it, you can see why this would be. In one of his articles, Geoff commented that hotel rooms “expire worthless every night”. And of course this is true of seats on flights as well. Well, that means that it becomes very, very hard to ignore a meaningful distribution channel that could fill up otherwise empty seats on planes or hotel rooms, even if that distribution channel comes at a cost.
And when you think about this from the customer / travel agent side – you can see that, in a highly fragmented market, the aggregation function provided by a GDS is very valuable. It’s difficult to see large buyers of travel services starting to comb individual providers – that would be an enormously labour intensive and impractical approach.
So, the GDS business is not without threats but overall I would say it has a very strong competitive position.
The software business
Amadeus’ software business shares a number of the attractions of the GDS business.
The software business is essentially one of providing inventory, ticketing, boarding, weight management, etc software to airlines, airports, hotels, train operators, and the like. But really, the dominant products are those supplied to airlines. And within that, there are two separate broad product lines: Altea, Amadeus’ organically-developed suite of products aimed at “traditional” airlines, and Navitaire, which Amadeus acquired in 2016 and which serves the “low cost carrier” customer segment (so, the likes of Ryanair).
The way this works is that Amadeus enters into a long-term contract with an airline customer for a given number of software “modules” (e.g. ticketing, baggage handling, aircraft weight management). The customer then uses the Amadeus software to manage the relevant aspects of its operations, and it pays Amadeus a fee per “passenger boarded”. So, like the GDS, Amadeus gets paid on volume. And the key thing for Amadeus is to grow the numbers of services provided, and the numbers of passengers boarded, over time.
This sort of business model has a lot of things to like. First – it has very high customer retention. Amadeus is providing critical software used in its customers’ day to day operations. So, it is highly integrated into the core of their businesses. Making a change from one provider to another is not something that is easy or done frequently. And as a result, customer retention is very high. (Of course – this does have implications for customer acquisition.)
Secondly, the nature of the fee model means that Amadeus gets predictable, recurring revenue, and incremental growth that is essentially free. To the extent that its customers’ number of flights grows over time, Amadeus should (assuming its customer base does no more than remain constant) capture a proportion of that increase for free. And customer retention is very good. In the 2010 IPO prospectus, the company stated that customer retention for the three preceding financial years exceeded 95% (across the whole business, so both GDS and IT) and in relation specifically to IT they said: “Our Altea PSS [Airline IT] contracts with airlines are typically for a duration of between ten and 15 years and include agreed unit pricing”.
And the company does report on contract wins and losses. There have been a couple of losses over the last few years – for example Air Berlin. But, that is on a customer base of nearly 200 airlines. I’d guess customer retention is still at least 90% – probably more. The customer relationships are very long-term. For example, Ryanair, which uses a Navitaire product (Navitaire was acquired by Amadeus in 2016), has contracted with Navitaire for over 25 years.
Thirdly, that fee model is actually beneficial for its customers too, because they only pay for services to the extent that they actually use them, and they don’t have to enter into large, risky up-front commitments. They will only pay Amadeus a lot of money if they have a lot of flights. They can turn something that was a big, up front fixed cost into a variable cost that varies in line with their business volume. So, the risk profile is attractive for airlines too.
Finally, it’s clear to see how using an outsourced provider such as Amadeus is superior to developing an in-house solution (which historically, would have been a likely competitor to using an Amadeus product – in the 2010 prospectus, Amadeus estimated 30% of the market was still held by internally developed products). Firstly, developing this kind of software is not a core competency for an airline. And secondly, having a few dominant software providers means that all airlines using a particular product benefit from scale in R&D spending that they wouldn’t get if they self-built a system. This is just a function of scale. Amadeus’ R&D spending, funded by its entire customer base, is far greater than the R&D spending of any individual airline could be.
Growth in the software business has been rapid. Revenue has grown from €456m in 2007 to €1,715m in 2017, and IT “contribution margin” (basically IT trading profit) has grown from €310m to €1,177m. These are respective revenue and contribution CAGRs of 14.16% (revenue) and 14.27% (contribution). And looking at operating metrics – the key metric is probably “passengers boarded” using Amadeus products, which has gone from 123.8 million in 2007 to 1,656.5 million. Not all of this growth is organic. In particular, Amadeus acquired a company called Navitaire, who provide airline IT solutions to low-cost airlines, in 2016. That provided a significant boost to revenues, profits and passengers boarded. However, the core growth of Amadeus’ Altea product has still been very strong. For example, if we measure from 2007 to 2015 (to exclude the Navitaire acquisition, which took place in early 2016), Amadeus’ IT growth rate is something like 12.6% (revenue) and 11.9% (contribution).
The effect of this is that the relative importance of the IT business, as compared to the GDS business, is changing. For example, in 2007, the GDS contributed revenue of €1,937m and operating profit of €935m, whereas IT contributed €456m of revenue and €310m of profit. By 2017, those figures were revenues of €3,138m and profits of €1,306m for the GDS, versus revenue of €1,715m and profit of €1,177m for the IT business. So IT profits are now close to equalling GDS profits.
Growth
Amadeus has seen significant growth in both aspects of its business – with growth in the IT segment being particularly strong. This is made up of several elements:
- Global increases in travel volumes as both its businesses are tied directly to travel volume
- Adding customers in its IT business
- Up-selling its customers to more IT products
- Acquisitions
In addition, Amadeus are attempting to widen their IT customer base to include hotels, railways, airports and the like.
I will estimate growth by assuming that Amadeus can at least grow in line with global travel (5 – 6% rate) and in addition will be able to add more airline customers over time (1 – 2% rate). So, that gives us a 6 – 8% growth rate (assuming all cash is distributed to shareholders and not invested in acquisitions).
I prudently assume no growth from expansion into adjacent markets such as hotels and airports. This is probably over-prudent as Amadeus has already signed deals with big customers such as Intercontinental Hotels and Premier Inn (a big U.K. hotel chain). However, arguably less prudently, I am also assuming that the GDS can at least maintain its market position and defend against trends towards disintermediation.
One key point to note is that the cost of growth at Amadeus is very, very low. Amadeus is (partly) a software company. It capitalises a lot of its R&D spending. So, it would be disingenuous to assess Amadeus’ return on capital by disregarding its intangible assets. But, by any measure, returns on capital are high. And much incremental growth really is free. Growth in passengers at existing customers costs Amadeus absolutely nothing.
For what it’s worth, growth in 2017 was as follows: GDS – growth in revenues of 7.3% and trading profit of 6.8%; IT business – growth in revenues of 10.8% and trading profit of 13.1%.
Capital allocation
I will deal with capital allocation quite quickly. Capital allocation at Amadeus is conventional. It’s quite like capital allocation at many other large, professionally-managed businesses. Basically, Amadeus has used cashflow to perform R&D, pay a dividend (which they have been increasing at quite a rapid rate) and make acquisitions. It is possible this is going to change slightly, as Amadeus recently announced a share buyback programme. However, the current share price could not be described as a bargain (see below) and I do not expect substantial value creation to come from capital allocation. The best we can hope for, I think, is that management do not do anything too stupid.
Valuation
I will value Amadeus on a “whole company” cash flow basis. Amadeus has converted 17 – 19% of revenues to free cash over the last several years. I think that is a reasonable assumption (maybe slightly conservative) for what the business can produce going forward. Revenue on a last twelve months basis is €4,852m. So, normalised free cash flow is roughly €873m (actual free cash flow for 2017 was in fact higher, at €922m). And we are assuming a growth rate of 6 – 8%. Importantly, that €873m of cash flow is truly “free” in that it already accounts for the investment required to grow at those rates. So, it should be available to distribute to shareholders. Amadeus has 437m shares outstanding. So, that is €2 of free cash flow per share, growing at 6 – 8% per year. What is that worth on a per-share basis? Geoff has written numerous articles on this. But I think a stream of cash flows growing at that rate with no further reinvestment required is certainly worth something like 30x (in the sense that, at that price, such a stream of cash flows is priced to a similar return to the overall market – an initial coupon of 3.3% plus growth of 6 – 8% gives a total return of 9 – 11%). If cash flow is €2 per share, that gives us a value of €60 per share.
Amadeus is undoubtedly expensive right now. It’s trading at pretty much exactly €60 per share as I write this. But honestly, I can’t say it’s overpriced at that level. I’d say it’s probably fairly priced. And in fact – if you asked me whether Amadeus is likely to deliver a market beating return at today’s price of €60 – I’d say, yes, I think that is likely.
However, I couldn’t be 100% confident of that. But, if the market were to offer Amadeus at 20x free cash flow – so, currently, €40 per share – I’d say that would clearly represent a good price for what is a very, very strong company.
Disclosure: I own shares in Amadeus.