By Ben Strubel of Strubel Investment Management, LLC
The red flags surrounding Universal Travel Group (UTA) are numerous. First, there is the company’s musical chairs approach to auditors; UTA has been through three auditors in one month. On September 1, the company dismissed Acquavella Chiarelli Shuster Berkower (ACSB) and hired Goldman Kurland Mohidin (GKM. Then, on September 29, GKM resigned and the company hired Windes & McClaughry. That is three accountants in one month. Second, the latest 10K reveals that auditors ACSB found material weaknesses in internal accounting and financial controls. The auditors’ opinion states it plainly: “The following material weaknesses were identified: The Company’s policy documentation of all controls identified during their assessment and remediation process was incomplete. Lack of technical accounting expertise among financial staff regarding US GAAP and the requirements of the PCAOB, and regarding preparation of financial statements.“ The third previous red flag identified is the company’s nonfunctional travel booking site. We won’t dive into these three issues here as they have been explored elsewhere, including Bronte Capital’s blog.
Now, there is another strange piece of news. Universal Travel’s announcement of the sale of all of its existing TRIPEASY Kiosks raises some questions. Why would the company sell the TRIPEASY Kiosks, which it has constantly told investors was its biggest competitive advantage? Instead, why didn’t the company license the buyer, Shenzhen Xunbao, to sell travel insurance on the kiosks? Why would UTA accept a two-year exclusivity deal? Why not five or more years?
First, here is some background information about the sale itself. UTA via its subsidiary, Shenzhen Yu Zhi Lu Aviation Service Company Limited (“YZL”), sold all 1,523 of its kiosks to Xunbao for $5.93M and will no longer own or operate them. Instead, the company will lease them, and it negotiated a two-year exclusivity agreement: “On September 9, 2010, our subsidiary, Shenzhen Yuzhilu Aviation Service Co. Ltd. (the ‘Company’), executed a purchase and sale agreement (the ‘Agreement’) to sell all of its 1,523 TRIPEASY kiosks to Shenzhen Xunbao E-Commerce Co., Ltd. for a total of RMB 40,301,417.73, or approximately $5.93 million (the ‘Purchase Price’). Pursuant to the Agreement, although the Company shall no longer operate or retain ownership rights to the kiosks, it will continue to have exclusive air ticketing, hotel reservation and package tour travel product sales rights in all TRIPEASY kiosks for a two-year period from the closing date of the agreement.”
Why Sell the TRIPEASY Kiosks?
Why would the company decide to sell the kiosks? The press release states: “We do not expect this transaction to reduce our top-line, at least for the next two years, as we have secured exclusive air ticketing, hotel reservation and package tour travel product sales rights via the kiosk network. Our travel product offerings are complementary to Shenzhen Xunbao’s travel insurance products and, as a result, we expect to negotiate a mutually beneficial arrangement to continue to utilize the TRIPEASY Kiosks as one of our multiple sales channels after the initial two-year period expires. In terms of cost savings, we expect an increase in our gross margin as a result of eliminating costs associated with the kiosks.” (emphasis mine)
So let me get this straight. The sale might reduce UTA’s top-line revenue (more on the margins issue later) after two years? How is this a smart deal? Also, what incentive will Xunbao have for continuing to grant UTA exclusive rights? If you are selling travel insurance, wouldn’t it be beneficial to have as many consumer travel options as possible on the kiosks. Indeed, the two categories where UTA has the lowest market share are air ticketing and hotel reservation. CTRIP and eLong have larger market shares. What’s more, airline tickets and hotel reservations are the two items most likely to be purchased via kiosk.
In addition, UTA claims that it will increase its gross margins and save on operating costs. But this claim is strange as well. YZL, the subsidiary that owns the kiosks, had gross margins of 90.54% in 2008. For 2009, YZL’s financial data was presented combined with another subsidiary that was set up specifically to serve more rural populations and thus lower margin customers. But the combined entity still posted a gross margin north of 80%. The costs from servicing the kiosks, whatever they were, had a small impact. The company even says so in its latest 10K: “Our air-ticketing and hotel reservation have much higher gross margin than our packaged tour business primarily as our revenue from air-ticketing and hotel reservation are the commission we generated and our costs of service are mainly business taxes, systems and related technologies used in operations, costs associated with payment processing, and allocation of costs of labor and facilities, communications, and utility expenses, which all together are not substantial.” (emphasis mine)
If the costs aren’t substantial, then why is UTA claiming it sold the kiosks because the service costs were substantial?
Universal Travel Claims TRIPEASY Kiosks as Competitive Advantage
Universal Travel for its part has always been touting the kiosks as an integral part of its business plan. From the latest 10K listed under “Competitive Advantages” it states: “As of December 31, 2009, we have 623 Kiosks in place to serve our customers. We plan to roll out an additional 1,400 Kiosks in 2010 in selected cities in the PRC. The Kiosks would enable our customer to make travel related inquiries and book their travel when they do not have access to a computer or an internet connection.”
The company’s website says: “’TRIPEASY Kiosks will be an important market trend indicator and revenue source for Universal Travel Group in the future,’ said Ms. Jiangping Jiang, Chairwoman and CEO of Universal Travel Group. ‘We will leverage our brand equity and awareness in Shenzhen to further expand our market share into other major cities with additional Kiosk distribution.’”
A September investor presentation also lists the kiosks as a key competitive advantage over CTRIP and eLong.
The 2009 10K touts: “Sales and marketing for the past three years account for very small percentage of our revenue, and as our TRIPEASY Travel Service Kiosks will be serving as an effective media platform in the coming years and a marketing tool for us, we believe our sales and marketing expenses will not increase materially.” (emphasis mine)
Why would the company sell what it believes is its most effective marketing tool?
Did Universal Travel Sell the Kiosks at a Fire Sale Price?
Finally, did UTA get a fair price on its sale? UTA hasn’t disclosed precisely how much it spent on TRIPEASY Kiosks, but from the 2009 10K regarding future capital expenditures we learn the company may “increase such expenditure to support new initiatives and developments such as the rollout of our TRIPEASY Travel Service Kiosks, which management estimates could cost up to $6,000,000 should its year-end 2009 target of 600 additional Kiosks be met.” The 10K also lists two trade deposits at YZL for the TRIPEASY Kiosks themselves and for design fees relating to the kiosks. It’s difficult to tell if the deposits represent full payment for the kiosks or not because of the language used in the 10-K so I’ve included two other estimates based on UTA’s capital expenditure notes in the chart below.
Using the deposit and design fee values we get an implied cost of $5,458.88 per unit for the TRIPEASY Kiosks. UTA sold all 1,500+ of its kiosks for about $3,800 a piece. They took a haircut of approximately 30% on the sale. If the servicing costs aren’t substantial as the company states, why sell the kiosks at such a low price? If the company was intent on selling the kiosks, why not wait until a better deal came along? The company has reported positive cash flow in aggregate over the past three years, so it’s not like the kiosks were a huge cash sinkhole that needed to be sold immediately.
Conclusion
In short, why would a company spend two years constantly and consistently telling investors that a certain asset, its TRIPEASY Kiosks, are an integral part of the company’s business and a key to its success only to turn around and sell those assets at a presumed loss with no guarantee that the company will have access to those assets beyond two years? This should be yet another red flag for investors regarding Universal Travel Group’s business.
Disclosure: No positions
