OpenTable (OPEN) Earnings Analysis: Buy, Sell or Hold?
After the market close on Tuesday, February 7, OpenTable reported its fiscal 2011 fourth quarter (December) results. The company reported non-GAAP earnings per share of $0.37, $0.07 ahead of the $0.30 consensus estimate. Revenue of $37.2m (up 21% over Q4 2010) was also ahead of the $36.8 consensus.
· Total Seated Diners in Q4: 26.8m, up from 23.6m in Q3 2011;
· Total Installed Restaurants at 12/31/11: 25,119, up from 23,866 at 9/30/11;
· North American (NA) Q4 seated diners: 24.6m, up 38% y/y;
· NA installed restaurants: 17,150, up 24% y/y (15,316 ERB, 1,834 Connect);
· Intl. Q4 seated diners: 2.2m, up 45% y/y;
· Intl. Installed restaurants: 7,969 (2,736 ERB, 2,037 Connect, 3,196 TopTable);
· Reservation revenues: $20.3m (up 32% y/y);
· Revenue per seated diner, total: $0.75 in Q4, up from $0.69 in Q3
· Subscription revenues (World-wide): $13.3m (up 14% y/y);
· Average Monthly NA ERB Subscription Price in Q4: $259
· Other revenues: $3.6m (down 5%, driven by lower third-party restaurant coupon sales);
· Q4 Cash Flow from Operation: $7.0m
· Q4 Total Cash Flow: negative ($30.0m), though the company completed a $50m buy-back.
Management believes they have 44% share of the 35k NA market for ERB; and 9% share of the 20k NA market for Connect.
Management believes they have 12% market share of the 735m NA market for seated diners in 2011 (includes both their ERB and Connect service offerings).
For FQ1 (March): None
For full Fiscal 2012 (December): No official revenue or earnings guidance.
However, qualitatively, seated diner growth in Q1 2012 is expected to decelerate from the 40% growth in Q4 2011. Moreover, operating expenses are expected to jump about 15% from Q4 to Q1, which is consistent with prior first quarters.
What It Means:
OpenTable's solid, "beat-and-raise" fourth quarter performance means the company is executing to its strategic plan. Revenue growth continues to decelerate, though not unusually quickly, nor driven by excess competition (as we'd feared after it reported its last quarter).
Postives/Upward changes to expectations:
· The low restaurant subscriber churn, still around 1% monthly;
· The relatively steady revenue per restaurant and revenue per seated diner - no noticeable impact from competition or from sub-par execution.
· The lowered share count from a buy-back that looks good ($38/share average) in hindsight. This is good both from an earnings-per-share point of view, and also as a sign of management's respect for shareholders.
Negatives/Downward changes to expectations:
· The continued deceleration in earnings growth. Consider the following Non-GAAP EPS calculation, had the company not done its aggressive 1.31m share buyback:
$8,937,000 Non-GAAP Consolidated Net Income / (24,096,000 shares + 1,310,000 shares) = $0.35.
When you compare this to the 2010 fourth quarter Non-GAAP EPS of $0.33, you see a company with annual earnings growth of only 6%, trading at a forward P/E multiple of 22.
Some investors might claim that OpenTable's international operations, which are in high-growth, high-investment mode, lower the company's overall profit and profit growth. But the international ops are not a discontinued operation, or incidental to OpenTable's strategy. Rather, they are the key to its growth going forward. Yes, revenue was and will remain growing closer to 15-20%, but only earnings can be returned to shareholders. And the terminal earnings growth cannot yet be predicted, given the more competitive international landscape.
· International revenue per seated diner is expected to decline from about $1.50 to around $1.25, as the conversion from TopTable to either ERB or Connect is driven for volume and market share gain, rather than for marginal profit.
· Days Sales Outstanding (DSOs) continue to climb, reaching 41 days in the most recent quarter, up from 34 in the year-earlier period. This is due at least in part to the higher mix of international business, which typically involves less-stringent payment terms. And while 41 days is not at all unusual for a traditional software company, it is unusual for a subscription-based software-as-a-service company that bills people monthly. So this will bear monitoring going forward.
· OpenTable's North American headcount declined slightly in the Q4 compared with the prior quarter. This wasn't explained by management in its conference call, which only mentioned that hiring had resumed in January. But the mere fact that headcount fell doesn't speak well of management's confidence that revenue can continue to grow at 20-30% annually. With only 10-15% market share in North America, it would seem like the growth opportunity remains quite large and ready to be serviced by an ever-larger direct sales force. Apparently not.
Valuation (DCF and Comparative Analysis):
As part of our analysis of OpenTable, we maintain a Discounted Cash Flow (DCF) model for the company. We have updated the parameters with the most recent Q4 data to arrive at our DCF value:
· Term: 5 years;
· Initial Cash Flow: $38.204 million (this represents the estimated annual free cash flow for the just-completed fiscal year);
· Short Term Cash Flow Growth Rate: 8% (far lower than the 75% CAGR over the last five years);
· Long Term Cash Flow Growth Rate: 4%;
· Discount Rate: 7.42% (derived using CAPM: Risk Free Rate = 3.14% from the 30-year Treasury Bond; 4.4% equity risk premium from Ibbotson; and a calculated Beta of 0.99);
· Current Share Count: 24.094 million.
Using these inputs, our calculated DCF value per OpenTable share is $57.65, about 30% higher than the current share price of around $44. DCF models have their flaws, but for companies like OpenTable that are generating steady amounts of free cash and which have only 10 - 15% market share, they can provide a reality check on the stock's current valuation. Note that the share count declined in Q4 thanks to the 1.31m share buyback, and even though the buyback has ended, the average share count will be lower in the March quarter, reflecting a full three months at the lower level.
The following table compares OpenTable and six other technology service and software-as-a-service companies:
Op CF Margins
MRQ Rev Growth
Float: Shares Out
LTM=Last 12 months, CF=Cash Flow, MRQ=Most Recent Qtr.
The primary conclusions we can draw from this table are:
· OpenTable's revenue growth is decelerating rapidly, but not unduly so. But continued investment in international operations means that earnings growth is decelerating rapidly as well.
· It seems unlikely that OpenTable will be able to sustain operating cash flow margins in the mid 30% range while it invests heavily overseas - not because of the capital investments, which of course aren't the same as operational, but because of more aggressive pricing and less aggressive payment terms.
What You Should Do About It (Buy, Sell or Hold?):
We are maintaining our "Hold/Neutral" rating on shares of OpenTable but we are more bullish on the stock's alpha-generating prospects. When we wrote our initiation report back in November, 2011, we were very concerned about increasing competition and its effects on pricing and turnover. However, we do not see either dynamic affecting the company at this time, particularly in its North American stronghold.
What we do see, however, is a distinct deceleration in OpenTable's North American business growth. It's still positive, just growing more slowly. International is expected to take up the slack, and spending is being directed toward that goal.
OpenTable continues to mature and continues to do almost everything right. But it won't be worth paying the premium valuation OPEN shares command until the company reaches and then maintains a sustainable earnings growth trajectory, which we feel should be in the 15-20% range.
Please see our complete research report on OpenTable, published on Seeking Alpha in November 2011.
Additional disclosure: I am long ARBA in the Separately Managed Account product for which I am the portfolio manager and in which I am an investor.