Amadeus: The IT Backbone of Travel - [Business Breakdowns, EP.237]

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2:27This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. This is Matt Russell, and today we are breaking down the travel IT giant, Amadeus. If you have booked travel with a travel agent or done business travel and used your system, there's a very good chance that was done through Amadeus's plumbing. They are IT for travel, and it goes well beyond what you see or interact with as a consumer doing this within the airlines, within hotels, inventory management, all of the behind the scenes work that make these logistical engines actually flow.

3:13My guest is Ben Needham, Portfolio Manager at 91 Asset Management. And he joined to cover why Amadeus might have some misconceptions in the market, the business and how it's grown and captured such dominant market share over the years, and what that looks like in terms of a value proposition on all sides of the equation. We also get into the AI debate and what that might mean for Amadeus and what a strong balance sheet could represent for Amadeus relative to some of its peers. So a very interesting niche business, a lot to discuss here. And Ben was a great guest to cover it all. Please enjoy this breakdown of Amadeus.

3:56All right, Ben, I am excited to have you here to talk about Amadeus. And this was admittedly one that took some time for me to wrap my head around as I was doing some initial research on it. So easy place to start was just to get your overview, description, how you would paint the picture of this business to a listener who is vaguely familiar or not familiar at all with this name. Thanks for having me, Matt. I think the best way of summarizing the business is as the gorilla of travel IT, but a friendly gorilla, which is able to grow well ahead of a structurally growing market, i.e. travel. And importantly, this is in a low risk way, given its diversification across geography, and travel provider customer, and the inflation link nature of how the revenue model works.

4:46So what do they actually do? There are three main parts of the business to understand. Firstly, they have a distribution business which links up travel sellers with travel providers in the indirect travel channel. It essentially aggregates content from the travel providers, i.e. airlines, hotels, rail companies, and supplies that to a pre-fragmented global travel provider ecosystem. This includes corporate travel management companies, online travel agencies, bricks and mortar travel agencies, super apps, meta channels, and AI agency perhaps. If you're making a travel booking via a travel agent or your company is booking a business flight for you, there's a good chance Amadeus of the plumbing that enables it given they have over 50 % market share and distribution which is actually rising.

5:33Distribution perhaps only gets a lot of the investor focus as the biggest business by profits is actually now the air IT business. This is predominantly the inventory management, reservation management and departure control system for over 50 % of the airlines globally, processing over 2 billion passengers boarded per annum. When you're making a booking on say Luftanser, Amadeus will process that booking and when you're boarding a Luftanser plane, Amadeus will facilitate the information flow all the way to the travel gate. Then finally, Amadeus also enables travelers to make reservations in hotels via its scaling hotel customer reservation business.

6:08Amadeus, in effect, is uniquely positioned right the way across the travel ecosystem, enabling the flow of content, bookings, transactions, and ultimately travelers. It's interesting as an industry, I would have previously assumed that most airlines built this system internally or had some type of internal software that would do this for them. Can you frame a little bit the space as a whole, how Amadeus fits into this ecosystem, whether there's competitors, how the technology kind of evolved into a place where there's such a key player in the industry? The RIT part of Amadeus is a community-based platform.

6:48And what that means is they're able to share economies of scale with their customers. They can amortize more of their R &D spend across more customers as they grow. And that's why airlines, which are pretty cyclical businesses, pretty capital intensive, they outsource these types of operations to people who can do it better than themselves. And that's why typically when you look at the airline space today, or the travel IT space today, within that, just over 80 % of air IT is outsourced to the likes of Amadeus, and then only 20 % today is actually in-housed. That's the background to the air IT ecosystem of a business.

7:26When you think about the market shares, Amadeus has over 50 % market share within the AIRIT space. So it processes over 2 billion passengers boarded per annum of a market size of just over 4 billion ex-China. The second biggest company is Sabre, which is 600 to 700 million passengers boarded. And then the majority is mom and pop players and or in-house providers. I think I read an anecdote that Lufanza had pulled away from Amadeus back in the mid-2010s because of their industry power, but then quickly reversed that decision and signed up again with them. Shows an indication of core competency, focus, and understanding where you can outsource and make that effective for your own system as well.

8:16What is the origin story to Amadeus? How long have they been around? They've clearly built up this advantaged position in the market. What does that trace back to? The business has been around for a long time and the history is really important. So they're actually created by the airline customers. Distribution systems were created in the 60s and 70s. And that was to enable airlines to process bookings and get close their customers in effect. And this is before dot-com. In the 60s and 70s, the airspace was deregulated. There was globalization. And within that, more airlines were created and more agencies were also created.

9:01There was a problem with the way the distribution systems work because they're owned by the airlines, gave preference to their own inventory. That was anti-competitive. So then there was regulation that came in following that deregulation. The airlines decided to sell off their distribution systems, and they merged. And that's when Amadeus was actually formed, which was in 1987. And that was following the merger of the distribution systems between Lufthansa, SAS, Air France, and Iberia at the time. That forms a distribution business of Amadeus today. In the early 2000s, they created something called Altea, which was the AIR IT business.

9:39And that is the customer reservation system, the inventory control system, and the departure control system that sits behind the distribution system as a whole which enables the orderly processing of bookings and then since then they've created the hotel it business that was in the 2010s when i actually started covering the stock over a decade ago they didn't really have much revenue or free cash flow there and that business is going from strength to strength and they also bulked out parts of their air IT and that hotel IT business via M &A. Interesting to hear horizontal expansion across travel.

10:19I certainly love businesses that were born from an industry consortium founding something together and then spinning it out on their own. You often see quite a few success stories in that category, Visa being one of the most obvious ones. I think you've tapped into the segments of the business. Is that how they split out revenue by distribution, IT, and then in the hospitality category? Are those the three buckets? There's three main divisions. The main one in terms of profitability is now Air IT. 15 years ago, that was 20 %-ish of group profits. Now it's up to 50%. 35 % of group profits of the distribution business, even though that gets a lot of the limelight and a lot of the focus.

11:05And then 10 % is hotel IT and other, which is 10 % of group profits. So the hotel IT business is the most embryonic. It has the lowest margins because of that. They're scaling very quickly. There's a lot of investment to enable the scaling of that business. Air IT business is the most profitable, almost 70 % contribution profit margins, which are pretty formidable. And then the distribution business, its contribution margins are in between Hotel IT and Air IT. You mentioned on the air distribution side of things, some of their competitors. In Air IT, are those the same competitors? You mentioned Sabre, which is a name I came across quite a bit.

11:45Is there more competition in that space? Less? Does it look similar to distribution? The competition is broadly similar. So within the Air IT business, Amadeus had 50 % market share, and then there's Sabre, which is just under 20 % market share, and then smaller operators, the airlines themselves, who in-house the technology. And then if you look at the distribution business, it's a similar type of shape in that Amadeus have about 50 % of market share. And then there's Sabre, who's a clear number two, with about 30 % market share. And then there's also Travelport with 20 % market share today. It's important to note that Amadeus do have a lot more scale than the nearest competitors versus the likes of Travelport.

12:35they don't actually have a air IT business. They're just a distribution player. The advantage of having both is enormous. I have a sense of what's going on with the buying an airline ticket, accounting for that in terms of the transaction and how that's actually working through the system. In terms of IT, does it get into accounting? I think I read something about the dynamic pricing, which can always drive me crazy in terms of seeing what flight costs do from this week to the next week, but a little more in terms of different ways that Amadeus is serving their customers, whether it's value add versus housekeeping.

13:13Depending on which division we're talking about, they're doing slightly different things. The distribution business is a network business and they're playing a role of content aggregation where they're taking inventory from the airlines and that can be in traditional edifact form or NDC form. and they provide that inventory or supply that inventory to the travel agents. So that's serving the indirect channel. That indirect channel is approximately 1 billion bookings per annum. And then on the air IT side, they're doing the reservation management for the airline. They're doing the inventory control for the airline.

13:48They're doing the departure control system as well for the airline. They also have revenue optimization tools. They do have revenue accounting tools, fare optimizer tools. Really what they're trying to do there is enable their customers, their airlines, to generate more revenue per passenger, make smart offers to the passenger, which are personalized. Airline customers can benefit from those initiatives. And that's clearly key in an industry which, as I said before, is pretty cyclical, quite capital intensive and very competitive. Generating that revenue from, say, an ancillary income is really key.

14:21And Amadeus enable that to take place. when they are taking the inventory and bringing it to the travel agents they're not actually owning or having that risk sit on their balance sheet in any way is that correct just in terms of the process that's absolutely true they will create offers in the distribution channel via the global distribution system that they have and they'll basically package those offers up and provide them to the agencies, but there's nothing on balance sheet. AI is something that comes up when talking about any space, particularly within any IT system. What would you say are the implications of AI for Amadeus and for the broader travel vertical?

15:11There's been some industry discussions about the implications to Amadeus of the potential adoption of AI agents at the top of the travel search funnel. with question marks on whether this will disintermediate the distribution business. I think this is largely a storm in a teacup, and I actually think they're very well placed at the top of the funnel for travel search becomes AI agentic led. And I think this for a few reasons. Firstly, you need to remember they are the IT backbone for their customer. The customer reservation system or order management systems are mission critical, will still be required in an all-in AI travel world.

15:47And this part of Amadeus represents the majority of profit today, so 60 % plus of it. Secondly, would AI agents really want the hassle of setting up the infrastructure to aggregate and orchestrate industry content when players like Amadeus already do this in a very economical way, with economies of scale enabling a very low industry take rate? My personal view here is AI agents might do things to improve the top of the funnel search, thereby potentially competing with online travel agencies where the industry take rate is incidentally also much higher, but the agents will still need an aggregator to pull together disparate data from the travel ecosystem with many different technology standards at play between NDC and Edifact, for example.

16:28Thirdly, there's also an airline push to dynamic and real-time pricing, essentially enabling them to generate more revenue for booking. This will put more demand on AI agents to get the right offers to the customer. With the move to NDC, there's actually been a big increase in something called the look-to-book ratios on the airline websites, which can get expensive and Amadeus helped to solve this problem. Fourth, one could argue the great thing about AI will be more personalization alongside the use of dynamic pricing for the airline, which could lead to a snowball effect before they're offering an order management system, i.e.

16:59Nevio, as well as many other products. Fifth, a big part of indirect channel and distribution revenues is for corporate travel management companies, where the complexity of booking is high. This complexity likely means it'd be difficult for AI agents to totally displace corporate management businesses. And even if they are displaced, eventually the AI agents will need a content aggregator and or someone to orchestrate the data. And then finally, if agents really do lead to chronic disintermediation of the distribution business, then peers who are much more distribution heavy with a much smaller IT offering and a lot of operational financial leverage are in deep trouble.

17:36So Amadeus can arguably swoop up even more market share across all areas of their business, IT included. So all in, I feel pretty good about AI as it relates to the distribution business and the business model as a whole today. From a revenue perspective, how much of this is per booking based on the amount of air travel versus contracted revenue? What's reoccurring versus what's exposed to cyclicality? How do you frame that? How does the company frame that? How do you think about that? Amadeus is predominantly a transaction processing business. And the way the revenue model works is it's a bit akin to a visa.

18:12They take a cut of the ticket price. Every time there's a booking made via the indirect channel and it goes through the Amadeus plumbing, they'll take a booking fee from that. And every time that there's a booking that's placed in.com with the likes of Lufthansa, etc., they'll take a very small fee from that. And there's pros and cons to that. The con is when air travel volumes fall, like they did in the pandemic, Amadeus's revenues really drew down because of that. The pro of it and the positive for the channel's point of view is they become a variable cost for their airlines. So when volumes do fall, there's no cost for the airline.

18:51Their take rate from an industry point of view is very low. On the air IT side, the take rate is about one euro per passenger boarders. On the distribution side, the take rate is about€6. We think there's a big runway when we look at the ability for that to increase over time as they provide more value for their channel and their customers. There's an enormous untapped pricing opportunity we think over time as Amadeus can share in the value creation with its customers as it enables more revenue per passenger to come through for their airline customers. Do you have any sense that one euro and six euros per passenger, what the airline would theoretically generate from the passenger in terms of revenue?

19:37It depends if you're doing short haul or long haul flights. If you're doing long haul, ticket prices can be anything north of a thousand euros, less than one percent on both sides of the business. If you're doing short haul, traveling from London to Edinburgh, then maybe you're a slightly bigger part of the overall cost. that still we think the value proposition is a very good one from an industry point of view. How are those fees determined? Is it some specific rate per transaction? What's the pricing mechanics of Amita selling into the airlines that use them or whoever is the end customer? On the air IT side, typically they go 10 to 15 year contracts with the airline customer, and it's pretty modular how they sell their products.

20:25If they're using Amadeus for its passenger service system on the ARIT side, you'll be using the departure control system, the inventory management system and then also the reservation management system. You will be using those three modules. They're fixed price in nature, but they're inflation linked over time. That has some positives if you do enter a down cycle. Typically what happens in a down cycle, pandemics aside when there's channel weakness volumes actually go a little bit negative and not too negative because what the airlines do is they lower price amadeus don't suffer with lower ticket pricing because it's fixed price and it's linked to inflation so at times of in chupain the revenue streams and the free cashless streams are very defensive if we go to the distribution part of the business it is slightly different there's something called home bookings and then there's also something called away bookings.

21:19When you're doing home bookings via a travel agency the fees are pretty low. Most people when they're making airline bookings if they're only traveling locally they'll typically go direct.com. That's the reason those prices are low. If you're doing away bookings so if you're traveling from say the UK to Australia and Quantos want to get their inventory to an agent in the UK to enable them to sell more, Amadeus facilitate that process and they can therefore charge a higher price for enabling that. The distribution business, a key concern with it is that there's disintermediation and more people are booking via.com.

22:00But for those away bookings, the role that Amadeus play is a really important one to enable inventory to be sold in different countries. And that's why they can charge at a higher price for that. And actually, the distribution business, the majority of revenues today, not necessarily volumes, but the revenues today are derived from away bookings, which is a bit of a misconception that we think people have on the stock. I'm not sure they're quite aware of that revenue mix being predominantly away bookings. Can you talk me through the net fee model in distribution? How exactly does that work? That's actually a good question, Matt, and an important one in the context of the discussion we were just having.

22:40An important element of how the distribution business works is the airline will pay the distribution system company, who will then actually pay the travel seller. So in effect, this means that the gross fees, i.e. the 6 euros, which I mentioned earlier, are very different to the net fees, which are 3 euros. And therefore, the industry take rate is even lower than what I assumed. So again, this is actually a really important point that you're touching on. I think the interesting thing to pull out here is in the evolution to an NDC model, the industry participants first thought that this would be dilutive to the revenue per booking.

23:20But actually, it wouldn't be dilutive at all to the net fee per booking. And if you look at the contribution profit per unit that Amadeus has made over time, which in effect is a proxy net fee per booking derivative, then you can see that it's actually steadily increased over time, which is a good sign of system health. And as the NDC model is evolving, actually, the actual net fee model that they have in place, where the airline pays the distribution company who then pays the travel provider, i.e. the travel agent, it's actually still remained mostly the case, because the airline often does not want a direct relationship with the agency, because it creates more of a cumbersome process.

24:02So the move to NDC, in all likelihood, probably won't be diluted to the per revenue economics and definitely should not be diluted to the contribution profit per unit economics. And also I should add this evolution to NDC, it's a gradual process. The airlines have to be ready to service the channel with NDC and particularly for the full service carriers. Actually, the rollout has been pretty slow, so they ensure that the channel is ready for them to provide an efficient service in this NDC switch. You mentioned that there is a concern about disintermediation or maybe less use of agents, more direct bookings.

24:41Is there any data that shows that piece of the market has shrunk materially over time? Or where does it stand today just in terms of percentage of the market? And if you have historical reference, that would be notable too. I think approximately 25 % of bookings are done in the indirect channel. If you look at Amadeus's booking trends in the distribution business over time, typically they've grown slightly below global passenger volumes. That's because of the prolific growth in low-cost carriers, which are a cheap form of travel, and the fact that you go direct to.com typically when you're making those bookings.

25:22The other aspect here is there is something called direct connects. Sometimes agents are directly linking APIs with the airlines. That process typically only happens in the home markets where there's a lot of volume going through that channel. When the volume is a bit more fragmented and when you're having to include small inventory loads from airlines in a different country, it becomes very difficult to manage tons of APIs. And that's why you go through the distribution system that Amadeus, Sabre, Travelport provide, as opposed to disintermediating them and having direct connects. That's another aspect to think about.

26:01Should I assume that there's a lot of overlap in the distribution and Air IT customer base in terms of those that use one are usually using both? I think that's right. Having both an Air IT and distribution business is a commercial advantage for Amadeus and to a degree Sabre in that you have more revenue to spread across similar customers. So you can therefore charge lower prices, arguably, for one or the other. And the other aspect of this is there's a slight halo effect in terms of bookability. If you are the Air IT provider, as well as a distribution provider, you know that that inventory is live, it's real.

26:45The bookability, therefore, can be better for the channel if your distribution system and your Air IT system are the same. There's a commercial advantage and there's also a potential customer advantage in that you don't get catch data, which is wrong. And you go to buy an airline flight and it's actually not there, which can happen. On the hospitality business, you mentioned AirIT was a much smaller percentage of overall revenue years ago versus where it is today. That has been something that has taken up more revenue mix, positive mix shift seen from that business. Is the hospitality business a similar growth engine for them?