I'm Parting Ways With This Former Highflier

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Many investors think that determining what stocks to buy is the most important decision to make, but I beg to differ. Deciding to part ways with a stock -- especially at a significant loss -- is an admission that, as investors, we were wrong.

Today, I'm announcing that I was wrong for being so bullish on Travelzoo (NAS: TZOO) , and in the true spirit of Moneyballing our decisions here at the Fool, I think it's worth examining where I went wrong.

As I review my three reasons for buying into the company, I'll share where my mistakes were buried. I hope you can learn something from my experience to help you become a better investor. Make it to the end, and I'll offer you access to a special free report that will introduce you to a company our top Fools think could be the next multibagger.


No. 1: The company has an excellent leadership team in place
Travelzoo was essentially run by Ralph Bartel and his brother, Holger, for most of its life as a publicly traded company. It wasn't until July 2010 that Holger turned over the reins to Chris Loughlin, who'd been running the company's European outfit since 2005.

I believed that given the enormous opportunity in Europe for both the company's Local and Travel Deals businesses, Loughlin was ideally suited to lead the company forward. As far as results thus far indicate, I was right -- revenue from Europe has increased 45% over the past 12 months. So my mistake was likely elsewhere.

No. 2: The company offers deals that simply aren't found anywhere else
At some level, this is still true. Travelzoo has three streams of revenue: search, Travel Deals, and Local Deals. When it comes to Travel Deals, it's still tough to beat what the company's weekly Top 20 has to offer. The problem is that this segment of the company, which accounts for just under 60% of revenue, is largely mature. Revenue contracted by 2% for Travel Deals last quarter.

The company's Local Deals were also the cream of the crop one year ago, as it aimed to produce just two high-quality deals per week in each established market. This differentiated Travelzoo from lower-end deals coming from Groupon (NAS: GRPN) and Amazon.com (NAS: AMZN) -backed LivingSocial. Since then, however, competitors have entered the space, and Travelzoo is no longer the only high-quality dealmaker in town.

No. 3: The company is very cheap to run and very profitable
When I made my bullish call one year ago, the company was fundamentally different from what it is today. Take a look at how some key metrics have changed over the past 12 months.

Quarter

Employees

Revenue per Employee

Year-Over-Year Revenue Growth (MRQ)

Operating Margin

Q1 2011296$125,00030%27.00%
Q1 2012360$109,1676%24.30%
22%(12.7%)Significantly slower(270 bps)

Source: Travelzoo Investor Relations.

Now don't get me wrong: Travelzoo is still quite profitable, but there are trends working against it right now. Headcount has increased rather dramatically as the company ramps up its Local Deals program, but it hasn't yet had the intended effect. With each employee bringing in significantly less, and operating margins being squeezed, growth has slowed rather dramatically.

A broken model
My mistake here largely has to do with how the deals space is playing out. The rapidity with which players have entered the scene has been far more significant that I would have guessed. Many new deals companies are running at significant deficits.

Clearly, these competitors won't be around forever, but in the meantime Travelzoo is seeing its market share among high-end deals eroded. Management claims that the company just needs to ride out this wave and allow for the lower-quality dealmakers to inevitably go bankrupt. When that occurs, the story goes, Travelzoo will have the leverage it seeks within the industry.

Management may be right, but if the past year has taught me anything, it's that I don't really have a firm grasp on where this industry is headed. When that's the case, it's usually a good idea to cash out and put your money somewhere else.

What should you do?
If you're currently holding shares of Travelzoo, you have to be heartened by talk of a buyout. Fellow Fool Rick Munarriz points out that potential suitors include priceline.com (NAS: PCLN) and Yahoo! (NAS: YHOO) , both of which have the cash and the motivation to add the company to their team.

If, like me, however, you think it's time to part ways with Travelzoo, I highly suggest checking out our new special free report: "Discover the Next Rule-Breaking Multibagger." Inside, you'll find out about a company that's changing the face of medicine, and how it's in the sweet spot for the retiring baby-boomer population. Get your copy of the report today, absolutely free!

At the time this article was published The Motley Fool owns shares of Amazon.com and Yahoo!Motley Fool newsletter serviceshave recommended buying shares of priceline.com, Amazon.com, Yahoo!, and Travelzoo. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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