OpenTable, Inc. (OPEN)

Background

In a perfect world, OpenTable’s name would hardly be spoken at its restaurant customers’ locations. Its nifty online reservation platform would leave few, if any, open tables available to the diner who tries to reserve a table over the phone. OpenTable’s easy-to-use software used by restaurant hosts would rarely require maintenance calls to OpenTable support centers. Such is the product OpenTable markets to its restaurants customers for fees – and to its dining customers for free.

Ease of dining reservation is the unique product offered by OpenTable to both restaurants and diners. The company carries no explicit inventory and instead relies on its fixed assets for generating revenue. Its two primary channels of revenue are subscription fees and reservation fees. Computer equipment and software used by restaurants are the basis for the subscription fees. Its intangible assets represent the ground roots for the technology that ultimately yields reservations.

Financial Health

There is little need for regular debt financing in OpenTable’s business. The company is free of debt, with the exception of a $5 million line of credit, which expires in July. Its leases are exclusively operating leases used for corporate office space. As a result, OpenTable is left with plenty of cash on hand, most of which it invest in short-term, interest bearing securities (and lately, a share repurchase program). Cash, short term investments and receivables make up over 40% of the firm’s assets.

As noted above, OpenTable is soaked in cash, owning a 1.92 quick ratio for the year ended December 31, 2011. The company believes its level of cash to be enough to support operations for “at least the next twelve months”. The liability on OpenTable’s balance that draws most attention from investors is its Dining Rewards Payable account, which makes up about 40% of liabilities and is discussed later in the report.

Sales

OpenTable has several ways of making money, but growth in diners is where it puts its focus. That’s why it’s a good thing that reservation revenue has vastly outpaced subscription revenue over the past two years. Growing reservation revenue means that restaurants are getting more of what they’re paying for. Naturally, subscription revenue isn’t sustainable without reservations. From the opposite perspective, a growing dining base can help command higher subscription fees in the future.

OpenTable’s shift in primary revenue stream is hardly groundbreaking. One would expect any firm in this business to begin to realize greater variable revenue as its user base expands. However, it is OpenTable’s rate of shift that is impressive. Reservation revenue has grown about three times as fast as subscription revenue over the past two years, moving from 43% of total revenue in 2009 to 53% in 2011. With 50% growth in diners in 2012, OpenTable can expect reservation revenue of over $117 million.

Notable Trends

OpenTable’s Dining Rewards Payable account is a strong indicator of company growth. Dining rewards are remitted to diners each time they make and honor a reservation. These rewards become eligible for redemption when a user had accumulated a minimum of 2,000 points and are classified by OpenTable as contra revenue. The 29% annualized growth in dining rewards payable since 2007 is comparable to the growth seen in diners and reflects a solidifying mature diner base.

While OpenTable works to expand beyond its four primary markets in North America (New York, Chicago, Washington D.C. and San Francisco), it continues to make headway abroad. OpenTable chose to tap three of the more robust global economies in Germany, Japan and the United Kingdom. With the help of TopTable (which was acquired in 2010), growth in the international diner base has grown at an astounding 97% annualized rate since 2007.

Share Value

OpenTable’s rapid growth helps justify a higher P/E ratio, just not the one its stock was boasting between 2010 and early 2011. Shares ballooned as high as $115, putting pressure on the company to meet daunting estimates in proceeding quarters. The inevitable happened when OpenTable’s still-strong earnings disappointed later in 2011 and growth-hungry investors fled from the stock. Shares are currently trading just over $40, or 46 times earnings.

The stock is currently trading just over eight times book value, a level of overvaluation that investors appear to be comfortable with for now.  The 13.4% growth in EPS over the past eight quarters points to earnings of 34 cents per share for the first quarter of 2012, a 21% increase from a year ago. Analysts are looking for earnings of $1.54 per share for 2012, pricing shares at just over $70 at year-end if the current P/E ratio is maintained.

Outlook

Because OpenTable’s product offering only serves full-service restaurants, profitability sinks when times get tough. Its stock could become a portfolio regular if the company finds a way to cash in on quick-service shops like McDonald’s. Such a move would likely require getting into mobile orders, in addition to reservations. The evolution of carry-out and delivery is a market that is quickly taking off and is one that OpenTable should consider targeting to reduce its dependence on a favorable economy.

What I am nervous about with OpenTable is another bubble in its stock price. Investors shunned still-remarkable growth a year ago, sending the share price tumbling for most of the year. OpenTable’s growth has spoiled investors and has made them a difficult crowd to appease. At $40 per share, I still believe the stock to be in “let-down” range and would use another earnings disappointment to my advantage, picking up the stock in the low 30’s or high 20’s.

Disclaimer: I do not have a position in OpenTable and do not anticipate having one anytime in the next two weeks. My evaluation of OpenTable does not reflect the opinion of my employer.

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