Thesis
OpenTable (OPEN) illustrates the fast structural changes occurring in our society toward the next stage of full digitalization. This firm installs an automated hardware and software reservation system for restaurants, which then interface with OpenTable’s website or smart phone applications, where diners can make free reservations. This next stage of full digitalization is often referenced as “Web 2.0.” OpenTable has the potential to become the next “iTunes platform” in the restaurant industry. The long-term profitability and growth of the firm is derived from the direction of the world economy and consumer sentiment given that its revenue correlates with consumer spending.
Over the last six months, U.S. consumer sentiment has been improving, retail has posted s strong turnaround, and the job market has illustrated positive signs of life. Improvement in these macro-economic variables should pay dividends for OpenTable as people enjoy more late nights out on the town. As well, the probability of a double dip in the economy is now unlikely. At this point, OpenTable is still scaling up at a low cost, with the power of an established economic moat, while leveraging its viral popularity and generating free cash flow with nominal debt. For these reasons, OpenTable has the potential to keep surprising investors.
With the recent acquisition of TopTable.com, a major player in the European space, we see the first sign of substantial expansion into foreign markets. With the acquisition, OpenTable gained 5,000 new restaurant clients and roughly another three million seated diners annually. This appears to be a smart move, however it could become worrisome if this is how they attempt to enter every foreign market as it could result in overpriced acquisitions.
OpenTable has ensured their success through executing multiple lines of revenue.
Below revenue is broken down into three separate categories:
1. Revenue is generated through an inclusive one-time onsite hardware installation and training fee at restaurants.
2. Restaurant customers subsequently pay a monthly subscription fee for the use of OpenTable’s software and hardware.
3. For every reservation created, OpenTable is paid a fee regardless of whether or not the customer shows up. If the customer does arrive for the reservation, the fee is higher. This revenue stream thrives off of repeat users.
When looking at the first line of revenue it’s simple to understand why it works well. Every restaurant is looking to increase its volume. Any type of tool that is going to allow a restaurant to potentially increase its volume in a cost effective manner is going to be a hot commodity. The demand for the hardware has the potential to become self-fulfilling in that restaurants will want it in order to remain competitive with other restaurants that already use it. No business in any industry likes to be behind the curve.
Restaurants today understand that using a technology platform such as OpenTable is not an optional tool but vital instrument to their success and profitability in a digital world. Thus, in our opinion the “bread and butter” of this firm is the second line of revenue. It’s not fancy, it’s not earth shattering, but it’s stable and very profitable given the low cost scalability and the monthly recurring subscription charge. A slight to moderate increase in volume equals tangible benefits for a restaurant. As OpenTable continues to become the new “standard” in making reservations, this should translate into increased loyalty and reliance on the platform by the restaurant.
The platform created by OpenTable is reminiscent to when iTunes first launched from our perspective. It is extremely user friendly, has a viral networking effect, and is tapping a giant consumer demand base that was previously unrecognized. We now see that one of the biggest reasons iTunes was so successful and profitable was due to the construction of an engaging platform that made users not only loyal to it, but repeat consumers. We see an identical situation taking place with OpenTable’s platform. Users are becoming more loyal and repeatedly it. This idea of an online consumer platform being used repeatedly by millions of users around the world gives OpenTable a substantial X-Factor. The firm has even taken action toward adding ancillary revenue streams such as SpotLight, which offers email based restaurant discounts. This third revenue stream is what gives OpenTable that sexy and mysterious tech aura that could justify a high PE multiple similar to other tech juggernauts.
Risks and Head Winds
In terms of a serious rival, OpenTable currently lacks one. This isn’t to say one couldn’t arise and or be in development currently, but as of right now we don’t see anything substantial on the horizon.
No matter how great any product, idea, and/or service, one of the biggest factors to succeeding in any business is quick scalability that doesn’t entail out of control rising costs and or investments. Currently, OpenTable does not appear to have an issue as they have been able to keep costs low while growing and are already generating free positive cash flow. However, this is something to keep an eye on.
There are risks and headwinds when attempting to penetrate any international market. Every foreign market will have its own set of preferences, cultural norms, and challenges. This is something that cannot be avoided. OpenTable’s ability to successfully navigate through foreign markets has yet to be seen. Looking at OpenTable’s positive impact from the acquisition of TopTable.com relative to foreign market prowess must be taken with a grain of salt because TopTable.com was already well established with 5,000 restaurants.
From a macro perspective, we can see that OpenTable is very dependent upon the health of the global economy. This firm is a transaction volume based business. Any economic contractions that increase unemployment rates and hurt consumer confidence will likely have an adverse impact on the firm.
Valuation and Modeling Method
We are rating OpenTable as an overall HOLD. Despite being bullish on the company we do not see the stock being undervalued as it holds a fair value of $72 in our DCF model and priced at $77.32 (01/30/2011). As well, the stock currently holds a trailing PE Ratio of 152. We would wait to see the stock lower in value and or want to see earnings before potentially upgrading it to a BUY. Still, OpenTable is a hotly debated stock so we went the extra mile to give bulls, bears, and those in-between an equal voice by providing multiple valuation scenarios.
Bear Scenario:
In a bear camp scenario, we forecasted a decrease in revenue growth from last quarter’s 43% down to 30%. We would assume no material improvement in lower operating costs as well. The fair estimate is $34. We’re pretty sure that somewhere, a bear investor is “fist pumping” in front of his computer like it’s the show "Jersey Shore" after reading this.
Neutral Scenario:
We fell into neutral camp where nothing materially improved or deteriorated. Here we assumed a quarterly revenue growth rate of 43 % along with operating costs staying in line proportionately. The fair value estimate this time is $72 which indicates the firm is still a little overpriced, but not by much.
Bullish Scenario:
In our bullish scenario the company continues to demolish the numbers and reach new highs. The fair estimate is $96. We forecasted quarterly revenue growth increasing by 7% to equal 50%. As well, we forecasted a substantial increase to bottom line growth due to increasing economies of scale. We dropped operating costs from 41% to 20%. Bulls, if this isn’t bullish enough we don’t know what is for OpenTable.
Conclusion:
We assumed under all scenarios that the long-term growth rate was 3% for terminal value using the Gordon Growth Method and a discount rate (WACC) of 5%.
Unusual Action
We would be remise if we didn’t mention that we noticed that the OpenTable has a short float of 43%, as of Jan. 14, 2011 according to Morningstar. Earnings will be reported on Feb. 8, 2011.
X-Factors
1. The firm operates three differentiated revenue streams and is quickly developing new one’s that are easy to integrate into the current business model. SpotLight would be the most easily identifiable.
2. The firm can easily take its current platform and test it out in new foreign markets without spending heavily in new R&D and or capital expenditures. Further, it has already done so successfully with the integration of TopTable.com in the European market.
3. OpenTable has created a profitable and user-friendly platform that flourishes in an environment of repeat end users. It’s difficult not to say it isn’t reminiscent of the iTunes platform.
Management
CEO, Jeffrey Jordan, has served in this position since 2007. Prior to this, he had multiple executive positions within Walt Disney and a successful run as president of eBay's PayPal division. In terms of his executive compensation for 2009, Jordan received a base salary of $360,000, which we found to be pretty fair given the firms performance under his direction. The overall stewardship and management of the firm looks to be fair and sound.
Financial Health and Analysis
OpenTable looks to be as strong as an Ox relative to financial health. The firm is all but debt-free and is extremely liquid. Looking closer at current assets to check the nature of its high liquidity, we see that it has roughly $87 million in cash and short-term investments. Even after the acquisition of TopTable.com it will still hold over $32 million once everything is said and done. It is safe to say we would expect the firm to continue generating strong free cash flow after reviewing the financial statements.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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