OpenTable: Short- And Long-Term Structural Decline

| About: OpenTable, Inc. (OPEN)

OpenTable (NASDAQ:OPEN) has been on a tear over the past month, with the stock surging 26% year-to-date. However, there has been no fundamental news out on the company to drive the stock higher. The surge in OPEN's stock price has been due to the overall rally in equities in January, a "BUY" ($46 target) recommendation published by Barclay's on January 9th, and rumors of Alger buying up a large stake in the company. The fact that OPEN is 44% short, fueled the increase in stock price as shorts were falling over themselves to cover this month. This has led to a short seller's ideal entry point, as the stock is now at $50.40 and is prime for some downward pressure. OPEN is a great service, don't get me wrong, however the company has a number of structural problems that are both near and long term: Competitive pressures are looming, margins are beginning to decline, OPEN does not know how to deploy its cash, and its valuation is just way too rich.

1) OPEN has had the luxury of holding a monopoly in the web-based restaurant reservation market within the U.S. for the past few years, but the company is starting to see competitors flock into the domestic market like never before. Active competition includes (launched by UK-based Livebookings), Urbanspoon's Rezbook, and Although Rezbook was officially launched a couple years ago, it has just started nipping at the heals of OPEN. And just recently launched Freebookings and Eveve are gaining share right from the get-go as these services are already developed and up-and-running in Europe, so they already have a head start. But the best part of it all? All the aforementioned basic reservation services are free! It won't be an overnight disaster for OPEN, but in tough times such as these for restaurant owners, you will start seeing restaurants switch to the zero-cost option while maintaining a similar reservation service quality.

2) I'd be lying if I said OPEN was a horribly-run company, as the company is indeed trying to stem new competitive pressures, but at a severe cost. OPEN's traditional ERB system is riddled with fees that are quite costly for most restaurants. OPEN charges a ~$1,295 hardware installation fee, a minimum monthly subscription fee of $199, and then a fee for each seated diner ($1.00/seat through OPEN's website, $0.25/seat through the restaurant's website). Seeing new competitive threats on the horizon, OPEN decided to launch OpenTable Connect at the end of 2010. This is a software-only service with no installation or monthly fee, but $2.50 per seated diner for all reservations made through Although "Connect" has only been around for ~12 months, OPEN is starting to see a decline in metrics. Monthly Subscription Revenue per Restaurant peaked in the 3rd quarter 2010 at $298, and it has dropped in one year to $234 (down 21%). That could mean three things:

  1. restaurants have started to switch over to the less expensive "Connect" option (after 1 year, as all ERB customers have to sign a 1-year deal);
  2. new restaurant customers are choosing the cheaper "Connect" option; or
  3. both. Either way, you should see OPEN's margins start to decline gradually (as they did sequentially in the 3rd quarter).

3) In November of last year, OPEN announced a $50 million share repurchase program. This shareholder-friendly endeavor should be positive news, and the market did initially perceive it as such. However, I see a few major problems with this repurchase program. First, OPEN ended the 3rd quarter with $80 million of cash. That means they have allocated 63% of cash on hand for this buyback. This seems rather aggressive from a liquidity standpoint, especially with no revolving credit facility. Second, the devil is always in the details: The stipulations to this buyback are rather unique. OPEN laid out no timeline for this buyback plan, and made sure it had the ability to discontinue the program whenever it wants. So, is this just a ruse to prop up the stock price? Third, this is a growing company. That means, the company needs to continue to invest in itself for growth, and also must continue to look for strategic acquisitions to add to its platform, like Can OPEN really not find any better uses for cash than buying back its own shares? And that leads me to my final point. At the time of the announcement, the stock was at $35/share. Granted, that was near its all-time low (albeit very much warranted), yet it was still trading at 33x 2012E P/E! Have you heard of any CEO who thought his/her stock was cheap at 33x P/E? Maybe I was wrong in point #2 - maybe OPEN is now a horribly run company.

4) OPEN is now trading at 46.9x and 28.8x 2012E and 2013E P/E, respectively (based on consensus estimates). These EPS numbers include stock comp expense, as (although some naïve investors might disagree) stock comp will become a cash expense once OPEN's high growth subsides. The company will still have to pay its employees. Some will argue that these valuation multiples are warranted given the company's growth trajectory, however total seated diners declined sequentially for the first time ever in the 3rd quarter, seated diners per restaurant continues to decline sequentially, and (to no surprise) OPEN's installed restaurant base growth has been slowing dramatically (both sequentially and year over year). This has (and will continue) to lead to more topline pressure and more margin pressure, as discussed above in #1. Go ahead and run a DCF on the business. In order to get to the current $50 stock price, you will have to assume OPEN can grow revenue 25% annually over the next 5 years, maintain 38% EBITDA margins (excluding stock comp expense), and apply an 18x terminal EBITDA multiple on the business. No question the web-based reservation market is still underpenetrated (as evidenced by OPEN's growth and new competition entering), but at that 25% growth rate over 5 years, OPEN's penetration of all 55,000 domestic reservation-taking restaurants would grow from 30% currently, to 94%. Is this realistically achievable in such an increasingly competitive landscape?

OPEN had been the talk of the town earlier in 2011 when the stock was at $115. It has since come down dramatically, but there is still money to be made in shorting the stock. Tuesday, February 7th is the beginning of the stock's trek down to $30/share. Talking to a couple Wall Street analysts and using their proprietary restaurant internet research, North American restaurants only grew by 4% sequentially, and seated diners grew 5-10% versus the 3rd quarter. This is not the growth consensus is looking for based on OPEN's average 4th quarter revenue estimates. In addition, on OPEN's 3rd quarter earnings call, the CFO guided for revenue per seated diner to tick down sequentially and for operating expenses to be up 5-10% sequentially. Consensus is assuming 19.5% yoy topline growth and 27% yoy EBITDA growth for this upcoming 4th quarter. Now, how can EBITDA growth outpace revenue growth if pricing is going down, and costs are going up?

All in all, with revenue metrics declining, seated diners slowing, margins compressing, and competition growing, OPEN's stock price has a long way down. $50 is just a great entry point to start riding the stock south, especially headed into Tuesday's earnings as a real catalyst.

Disclosure: I am short OPEN.

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