OpenTable Inc. (OPEN) is the largest provider of reservation services to the restaurant industry in the US. OPEN is a very good business, but it is priced for perfection and its growth is slowing rapidly.
OPEN has an online platform that allows consumers to book reservations for free to a collection of fine dining establishments. In Q3 2012, the company seated about 300,000 diners per day in the US, or about 16 diners per day, per restaurant. In sum, the company will generate about $160mm in revenues for 2012.
That has translated into a profit of about $1,700 per restaurant customer annually. However, the company is running out of fine-dining restaurants which likely provide the most revenue. In other words, the quality of the average restaurant is deteriorating. To keep growth up to WallSt. expectations, OPEN is adding more and more lower ticket restaurants which will not drive the same amount of revenue per restaurant.
How do we know this, besides seeing revenue per restaurant is stagnant? OPEN on its website categorizes its restaurants into price ranges, $$, $$$, and $$$$. These price buckets roughly equate to Under $30, $31-$50 and $50+ for a meal per person. OPEN also shows on its website new restaurants for each area. I have tabulated the Top 15 markets (which account for roughly 62% of OPEN's US-based restaurants) to see the breakdown between price categories of OPEN's restaurant customers.
So, we see that for the Top 15 markets, 66% of all restaurants on the OPEN platform are $$ restaurants, and 28% are $$$. Now, looking at the statistically significant 499 new restaurants (about what OPEN adds in 2 months) we see a significant discrepancy.
82% of all new restaurants are less-profitable $$ restaurants. Also, whereas 28% of their base is bread-and-butter $$$ restaurants, only 14% of the new restaurants fit in that category. This is a huge problem and points to saturation in the most profitable $$$ and $$$$ categories!
Looking at the numbers by city also reveals disturbing trends. This deteriorating marginal restaurant effect is not limited to a few cities. This happened in 14 out of the top 15 markets!
The detioration in $$$ restaurant percentages also happened in 14 out of 15 cities.
Of note, the 1 city out of the top 15 that didn't see deterioration was Phoenix, which had by far the smallest number of new restaurants added (8)!
So, it is obvious that a disproportionate number of new restaurants are of the $$ variety. Cheaper restaurants, on average, likely take fewer reservations. They also are more likely to use OpenTable Connect, and thus not paying monthly subscription fees. A good example of a new $$ restaurant is here. Comparing that to a $$$ restaurant such as this or a $$$$ such as this, one can imagine where more reservations are going to occur.
Moreover, not only is OPEN seeing the quality of their customer adds deteriorate, they are adding fewer restaurants on a YoY basis. Fewer new customers with a less-profitable mix is a custom-made recipe for a slowdown.
Simply, growth in OPEN's most profitable segment has hit a wall. OPEN has come very close to reaching saturation in its most important market categories.
OPEN currently trades at $55.82, or 56X trailing-twelve-months (TTM) GAAP EPS of $1.00 or 35X TTM non-GAAP EPS (They are VERY generous with handing out options to employees). Such a valuation is not sustainable given detiorating customer metrics and near-saturation in their most profitable market categories.
Moreover, if one looks at what the valuation of OPEN might be in a fully saturated market, it is not pretty. OPEN estimates there are 35,000 reservation taking restaurants in the US. If they got 80% share (some chains will not use their service and competitors like UrbanSpoon, Livebookings.com, and Eveve are making progress), they would have 28,000 restaurants. If those restaurants each netted profit of $2,000 annually, they would have $56mm in operating profit for the US. The $2,000 is a stretch as the current number is $1,700 annually and we have shown that incremental restaurants being added are less profitable. So, $56mm in operating profit at saturation would likely receive a 10X EBIT multiple. That gets us to a valuation of $560mm for the US business, its most profitable by far. OPEN's current valuation of $1.25 billion more than accounts for all of the potential profits it may ever earn. Simply, OPEN is overvalued.
Disclosure: I am short OPEN.