By David Sterman
Growth investing is still the name of the game if you want to score big gains. Investors in high-flying stocks like Chipotle Mexican Grill (NYSE: CMG), Salesforce.com (NYSE: CRM) and Priceline.com (Nasdaq: PCLN) have scored major gains in the last few years. Yet such high-flying stocks also bring real risk. If investors change their opinion, then shares could get crushed.
That's what happened to Netflix (Nasdaq: NFLX), which tumbled sharply in 2011 on the heels of operational miscues. But perhaps no stock has suffered from a change in perception like OpenTable (Nasdaq: OPEN), the leading provider of restaurant reservations systems in the world. The stock, which went public in 2009, went from loved to hated in a heartbeat.
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Back in 2010, investors looked at the company's growth rates and assumed they could continue for a long time to come. With the exception of an economy-related slowdown in 2009 when sales grew just 22%, OpenTable's revenue has otherwise risen by at least 35% every year since 2003. With that kind of growth in place, investors and analysts came to forget about the law of large numbers, valuing this stock at more than 100 times projected profits last spring.
Sales reached $140 million in 2011 and OpenTable was already entrenched in a number of restaurants. So when management began to speak of a maturation process last spring, investors got spooked. Scorching growth was no longer to be expected, and 20% annual growth would be more the norm.
From great to good... and that's OK
This is my kind of stock. Great growth has become good growth, and as a result, valuations have gone from absurd to reasonable. The reasons why this stock should have fallen from its triple-digit peak are quite clear. But OpenTable now looks oversold, and a move back toward the $60 mark is a real possibility.
OpenTable's stunning growth over the last decade was due to excellent management execution. The company was able to rapidly expand the number of restaurants using its reservation system, creating the "network effect" benefit, which means that the greater the number of restaurants signed onto the system, the larger the audience of consumers that will use the site. This in turn makes the platform appealing to more new restaurants. By the end of last year, 44% of restaurants within its addressable market had signed up, and almost everyone has stuck around: the company's 1% churn rate is due to restaurant closings, not to customer defections.
Success invites competition, however, and over the course of 2011 investors began buzzing that OpenTable couldn't maintain its high market share. But competitors are not really gaining traction. For example, the industry's second-largest player, Urbanspoon, works with just 1,200 restaurants, making an average of 25 reservations per month. For OpenTable, those figures are 17,000, and 475, respectively.
The road ahead
Of course, with 44% of the U.S. market already signed up, OpenTable shouldn't expect to grow more than 10% to 15% per year. But that's why the company is gearing up for an international expansion, as most other markets are virtually untapped. Investors fretted that an expansion to Europe and Asia would crimp profits, but it's notable that OpenTable actually requires very little expenditure to fund expansion. The company built up its U.S. base very quickly, even as capital spending remained below $10 million every year. (This allowed free cash flow to soar from $11.7 million in 2009 to $32.5 million in 2011.)
The international push should help OpenTable boost sales roughly 20%, not just in 2012 and 2013 as analysts currently expect, but into the middle of the decade as well. That means sales could hit $200 million by 2013 and $300 million by 2015. The bottom line could move higher at a commensurate clip, hitting $3 a share by 2015 (compared with $1.28 a share in 2011 and a projected $2 a share by 2013).
Risks to Consider: The U.S. economy remains the wildcard. Consumers have begun dining out more frequently as employment trends improve, but the nascent economic recovery is fragile and any setback would make it harder for OpenTable to grow at a 20% annual pace.
Shares have come up off their lows and now trade around $42. Goldman Sachs sees shares rising to $57 in light of the company's "competitive position in core (North American) market and long-term opportunity abroad." Analysts at Citigroup have an even more aggressive $67 price target, citing the company's $4 a share in cash, a $52 a share value placed on the North American business and another $11 a share implied in the company's international business.
By my math, this stock is worth around $60, or 20 times that 2015 profit target of $3 per share I mentioned earlier. That's a 50% gain from where the stock is now. It could take 12-18 months for investors to look ahead to the mid-decade growth path, so some patience is required.
Disclosure: David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.