OpenTable (NASDAQ:OPEN) is an e-commerce business that connects reservation-taking restaurants with people who dine at those restaurants. Customers no longer have to rely on restaurant recommendations or search phone numbers of restaurants. OpenTable does everything for them. They simply go to Opentable's website, browse around, and book a place to eat. The idea is great, and the business is doing fantastic. The company went public mid-2009. For 2010, its shares have gained 168% YTD, making it one of the best performing stocks of the year.
Today the stock is trading at $70 a pop. The real question is: Is this price justified? Let’s take a look at OpenTable's quarterly income statements since it went public:
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Revenue has grown at an average rate of 9.35% quarter over quarter, or roughly 43% on an annualized basis. Gross profit has grown at double that pace, suggesting economies of scale — a good trend. Net income has been increasing at even a higher pace. At first glance, this appears to be a great sign. However, dig a bit deeper, and this statistic is slightly alarming. OpenTable’s operating income is equal to its gross profit. The only significant expense separating gross profit from net income is income tax expense. This means income taxes have been trending downward. Let’s take a look:
A common bull argument for OpenTable is that EPS has been growing consistently faster than expectations. This is true, and earning surprises have helped move shares of OpenTable even higher. Erratic income tax expenses may be the reason that analysts have consistently underestimated OpenTable’s quarterly EPS. Incomes taxes are fluctuating wildly, and trending downwards. In Q3 of 2010, income taxes were 15.60% of operating income. If income taxes were a more reasonable 30-35% of operating income, diluted EPS would have been $0.1246-0.1342 instead of $0.16 per share. This range is only slightly higher than the mean analyst estimate of $0.116. The decreasing tax rate trend suggests that OpenTable manages to pay a lower tax rate on higher earnings. This is not sustainable, and will reverse in the future.
Meanwhile, OpenTable's income sheet fundamentals are strong. Revenue growth is high, gross profit is growing at an even faster face (implying economies of scale), and net income is growing very quickly – faster than analysts estimates.
The balance sheet tells a similar story: Zero debt, great liquidity, no red flags. A perfect picture balance sheet.
What about valuation? This is where an otherwise sound investment turns ugly. OpenTable’s valuation is completely out of control. An analysis over at Valuehuntr does a great job summing up the valuation here.
The author conducts three different valuation analyses. The first is based on market capacity. It uses information from management discussion, the National Restaurant Association, and revenue metrics calculated from OpenTable's quarterly reports to gauge the company's global revenue capacity . It figures the world market for online restaurant reservations to be ~$800 million. This means that if OpenTable had a complete monopoly on the entire worldwide online restaurant reservation business, it would have revenues of $800 million.
Today, OpenTable’s market capitalization is $1.61 billion, or double its revenue capacity. To justify its current share price, OpenTable is expected to capture the entire market share of its primary business, generate equivalent revenues by some other means, and operate with no expenses. These are obviously unreasonable expectations. Valuehuntr's revenue capacity model projects an intrinsic price between $22-44. Valuehuntr also notes that international market capacity risks increases beyond the National Restaurant Association's projections, which would render a higher intrinsic price -- but still less than today’s $70 market price.
Valuehuntr's analysis also looks at valuation multiples. It compares P/E and EV/EBITDA of comparable firms and applies them to OpenTable's earnings and EBITDA. This analysis renders an intrinsic price between $14-19. My take on this analysis is that the firms he uses as comparable are slightly further into their growth phases than is OpenTable, and their expected future growth rates are lower than OpenTable's. So the intrinsic price Valuehuntr estimates may be a bit of a low-ball. However, even using double the multiples would render an intrinsic price range of $28-38; again, far less than the market price.
Finally, Valuehuntr runs a Discounted Cash Flow (DCF) analysis using worst-, base-, and best-case scenarios. The DCF yields an intrinsic price between $8-28 per share. This once again follows the theme of an outrageously overvalued security.
While I do think the previous valuation analysis provides some insight into the value of OpenTable, I also believe that there are better means to value this business. In my opinion, the best way to value a growth company is by using a growth-based valuation model. This is the type of model that investors are using to size up the value of this company.
Below is a simple growth-valuation model I have created, taking 2011 EPS estimates and applying a 50% growth rate in EPS. Over the course of 10 years, I assumed earnings would decrease at 20% each year until 2021. This gives me an estimated 2021 EPS of $7.41. I further assume that in 10 years, the company will be in the mature growth stage of its life cycle, and be trading at a P/E ratio between 10 and 25. Based on these figures, I calculated the 10-year return and compounded annual return. The model spits out an annual return of between 0.54% and 4.96%.
Clearly, my EPS growth model does not do justice to OpenTable’s current share price. You're better off buying a 10-year T-bill to get the same return at virtually no risk. However, these returns are sensitive to my implied growth rates.
Some may argue that my assumed growth rates are too conservative. “An average of 25% growth each year for the next 10 years? Are you crazy? OpenTable is the next Google (NASDAQ:GOOG)! There'll be a 40% average per year minimum!”
Okay. For argument's sake, let's assume that 2012 EPS will double and then the growth rate will decrease at 20% per year. Using these assumptions, the annual yield of a common share in OpenTable is between 6.07-6.75 percent. While this is quite a bit higher, it is still under-performing the average 10-year growth rate in the market over the past century.
There are also non-fundamental signals that suggest OpenTable’s stock price is inflated. Insider trends have been extremely negative. There has been a massive sell-off of shares by insiders in November and December. This suggests that the insiders feel that the stock price is overvalued.
Also, short interest has been rising, gradually increasing over the past few months in response to OpenTable's stock price surging. As of today, 40.8% of OpenTable’s float is short interest. Nearly half of the actively traded shares are sold short! This implies that there is a large community of investors that agrees that OpenTable is overvalued.
In terms of fundamentals, OpenTable is running a great business and its financials are rock solid. However, the current market price is unjustified from an investment standpoint. In addition, non-fundamental trends such as insider transactions and short interest suggest OpenTable's stock price is positioned to decline in the short-to-medium term.
To put this analysis in layman’s terms, consider an analogy of buying a car. OpenTable is the Lamborghini of its sector. Lamborghini has far better fundamentals than the average car, has far better expected performance than most other cars, and is priced ridiculously higher than most other cars. Lamborghinis are like the most attractive growth stocks. They are sleek and sexy to own, and they are the most attention-grabbing car on the block.
However, from an investment standpoint, the person who buys a Lamborghini is making a terrible financial investment. While the car is sexy and well-built, the price is not justified by any means. When it comes to an investment, you're much better off buying a Honda (NYSE:HMC).
Disclosure: I am short OPEN.