There’s a wise, satirical twist on an overused Wall Street saying that goes like this: “The Trend Is Your Friend – Until It Ends.”
Indeed, watching OpenTable (Nasdaq: OPEN) surge ahead yet another day on no significant news makes one wonder when this trend will end. The stock closed at $107, which means it’s a $2.5 billion company trading at a bubble P/E of 183. Yet for all that, earnings were a mere $5 million last quarter.
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With OpenTable up 29% in the last 11 trading days, traders ponder whether there are fundamental forces or technical forces at work. Since there’s been no major news releases or significant changes to fundamentals, one turns to the evaluation of technical trading factors to see what might be lurking behind recent gains and then try to determine if/when those factors will change.
Here are two clues as to why the stock had one more day of gains on Wednesday, but soon may give back gains – or even gap down significantly:
1. March Quarter-End “Window-Dressing”
2. Short Squeeze
Both of these factors have a terminus to them.
“Window dressing” occurs when fund portfolio managers need to make their quarterly fund performance “look good” by buying holdings of winning stocks and jettisoning their losing holdings. Then they can boast to their investors:
“Because we’re so savvy with your money, we have shares of OPEN in our portfolio and it went up 50% this quarter.”
After all, which fund manager wouldn’t want to be able to show OPEN in their portfolio because OPEN is, in fact, on the road to having gained about 50% this quarter if current prices hold to the close on March 31st?
Another form of window dressing is when fund managers purposely buy shares of small or mid-cap stocks at quarter end to push share prices up and thus enhance the percentage gain that stock shows for the quarter. For a stock having a low float (more easily manipulated), it doesn’t cost the fund that much to prop the stock up at quarter end, provided the stock doesn’t tank before they can sell those same shares after the last day of the quarter is over.
Quarter-end window dressing definitely ends at month end. The unnatural buying/selling due to this phenomenon has to be subsequently unwound by portfolio managers after their quarterly ending statements have been “dressed up.” This is because their intention was primarily to be in the stock temporarily, or to prop up the stock if they already owned shares to make their fund performance look stellar.
When you have enough fund managers trying to “unwind” their window-dressing shenanigans (unloading the shares they just bought to prop up share price), those stocks often drop in the days following quarter-end. For low-float stocks like OpenTable, it could be a lot of volume of shares trying to slip out of a small doorway on April Fool's Day after the March quarter has ended. Did I say “fools?”
2. During a short squeeze, shorts are forced to liquidate their positions as a stock runs up. Fear of more losses or margin calls force them to close their short positions – which means buying back the shares they shorted. This buy-to-cover activity levitates a stock beyond belief and people new to the markets often exclaim,“who is buying at these nosebleed prices?” – because they don’t understand the underlying mechanics of a short squeeze.
In reality, no one is buying at all because shorts buying to cover is not the initiation of new long positions. Short covering, therefore, doesn't represent long buyers who are locked in at $100+ per share and who will hold onto shares in hopes of higher prices. Rather, the position vanishes and the shorted shares that were borrowed are returned to the brokerage who lent them to the shorter.
Margin calls are usually "T+3" (after 3 days from initiation of the margin call the short holder must either buy back shares or wire in money to cover the margin call). So it’s very likely that many shorts were forced to buy-to-cover in recent days and that has caused OpenTable’s spike in share price. This gives the illusion of strength for OPEN, but much of it was probably short-covering and not long buying, given that we know a short-squeeze has been aiding the run-up.
OpenTable has a large short interest, at about 4 million shares as of the most recent short interest date of Feb 28th. Much talk is expended about how having a lot of short interest in a stock means short covering will somehow magically propel the stock higher and higher as more shorts initiate positions and then get burned as the stock keeps going up. But this is not always true. There are often times in which enough shorts capitulate and close out their positions at a loss such that there isn’t enough short cover activity to hold the stock up any more.
With OpenTable, in the past 5 trading days, about 8 million shares have traded. Given that there were 4 million shares short on 2/28/11 when the stock was about $90/share, it’s very likely that a sizable percentage of those 4 million short shares have been closed out.
The longer OPEN shares stay at this price level or lower, the less shorts will be under pressure and more shorts will have been washed out by margin calls, so there will be less forced buy-to-cover activity to hold the stock up this high.
A LOT OF AIR BELOW
Because short squeezes sometimes run out of steam rather quickly (when the "weak hand" shorts have been forced out), it leaves a stock perched high with no natural buyers left at high prices, so the stock implodes on itself.
SHORT SQUEEZE & WINDOW DRESSING CONCLUSION:
With OpenTable, it just so happens we currently have a confluence of two temporary technical bullish forces (Squeeze & Window-Dressing) that will likely end soon. So a smart trader looks for either of the two symptoms and waits until things appear irrational (like Wednesday when OpenTable spiked to $107 in the morning on no news or upgrades) and then take a short position.
NEW ANALYSIS OF POTENTIAL TO GROW INTO ITS ADDRESSABLE MARKET
There has been much talk about what OpenTable’s “addressable market” is of the total restaurants. The company’s very own Form S-3 filed with the SEC states:
Restaurant Industry Background
The commercial restaurant industry is broadly divided into "quick-service" and "full-service" segments. We target our offerings to full-service restaurants that accept reservations. We believe based on our internal estimates that there are approximately 30,000 reservation-taking restaurants in North America that seat approximately 600 million diners through reservations annually, though this number fluctuates with economic and other conditions.
Per the company’s February 2011 earnings release, they had 14,795 of those 30,000 and growing. Given stated growth rates, some point in the next year or two, the addressable market will be captured by OpenTable and competition. It will be a saturated market.
OK, now let’s look at the potential for OpenTable to grow into their addressable market.
The CEO states in an interview on Jim Cramer’s “carnival show” (aka CNBC’s Mad Money) on February 10, 2011:
We sat 62 million diners in North America last year [meaning 2010] and that’s only 9% of diners seated through reservations in North American restaurants. So we take analogous categories like Hotels, Airlines, and Event Tickets where they had perishable inventories. They’re 50-70% and growing every year [meaning 50-70% of reservations for these items are done online]. The reason we believe we’re 9 [percent] is we haven’t aggregated all the inventory yet but we think the consumer wants to book reservations for restaurants just like for flight and hotel and event tickets.
After seeing this interview, one couldn’t help but think how misleading it seemed for the CEO of OpenTable to make a comparison between restaurant reservations online and flight/hotel/event reservations – and for Cramer not to challenge it.
In order to PROPERLY make a comparison between restaurant reservations and reservations for hotels, airlines and events, we simply need to ask ourselves two questions:
1. RESTAURANT RESERVATIONS: What percentage of restaurant diners make reservations versus walking by and realizing they’re hungry or dropping in after shopping or a movie? It's fairly low compared to flight/hotel/event reservations. Of the percentage that do make restaurant reservations, how many of those diners find the convenience of online reservations has significantly more utility than simply using their cell phone? When answering the question, keep in mind the many questions you can ask a live person on the phone such as: What are your specials tonight? Can I get a table outside with a baby seat too? Do you have parking for diners? Most people would probably answer there's sometimes an advantage, but not a huge advantage. After all, a restaurant reservation is quite simple (how many diners and what time?
2. FLIGHT/HOTEL/EVENTS: What percentage of all people flying on the airlines “book” a ticket versus a walkup? It’s a very high percentage. Ditto for hotels and events. Of course, a high percentage of those people make a reservation for those items. And, of course, they have significantly more reasons to reserve online:
Airline, hotel and event reservations are far more complex decisions than dining and they’re not as spontaneous.
All of the above (flight/hotel/events) usually cost far more than dining, so consumers want to carefully evaluate with a lot of instant information.
Higher need to comparison-shop. Because of the higher cost of these items, people are far more likely to want to comparison shop, hence, far more people go online for flight/hotel/event reservations.
There is considerably more visual complexity needed to plan a trip or buy tickets for an event. For trips, you need to look at flight schedules, seating arrangements and discounts. For events, you definitely need to see an instant seating chart before buying those concert tickets.
For restaurants, a reservation is very basic: How many people and what time?
So it seems fairly obvious that there would naturally be a FAR higher percentage of reservations done on-line rather than reserving by phone for flight/hotel/events because they need visuals and detailed price comparisons. Thus, 50-70% of flight/hotel/events being reserved online versus by phone is not surprising, but it would be highly unusual for that high percentage of all restaurant reservations being done online.
Realistically, perhaps the steady state of OpenTable’s restaurant reservations might be, say 9-15% of total restaurant reservations. Not a huge growth over current levels. After all, OpenTable has been doing this for over 10 years and their penetration is still only 9%.
The notion of being in the early stages of growth may be overblown and investors should ask why the CEO of OpenTable would have made an unrealistic comparison between restaurant reservations and flight/hotel/event reservations to imply to investors that it’s likely that OpenTable could someday capture 50-70% of the reservations made in the restaurant reservation business when common sense as described above tells us otherwise.
Poorly thought-out, misleading sound bites like these help create an aura of a company at the beginning of a huge growth cycle, when the growth may in fact be slowing due to competition and saturation of their own addressable market. Newbie investors watching Cramer Carnival interviews like the CEO interview on February 10th, and then basing their investment in OpenTable on these incorrect premises are risking their money on an overvalued high-flier.
Could that be why some stock message board posters are posting comments like: “OpenTable or OpenFable?”
Disclosure: I am short OPEN.
Additional disclosure: The author makes no warrant for the accuracy of the content herein other than the links provided to traditional online sources of information for verification purposes. Additionally, investors shall not take any comments stated herein as advice to buy or sell any equities and if investors do so, they acknowledge that they have done their own proper due diligence and proceed at their own risk.