Should You Reserve a Place in Your Portfolio for This Stock?

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OpenTable (NASDAQ: OPEN), a provider of online and computerized restaurant reservation services, helps restaurants and diners transition from traditional phone reservation methods to online and mobile alternatives.

OpenTable’s solutions solve real problems

Traditional restaurant reservations, a combination of phone and voicemail reservations and manual record keeping on paper, are inefficient for a few reasons.

Firstly, although searching for restaurant information on the Internet through company websites, blogs and message boards is pretty common, customers are typically unable to complete the restaurant booking process online for most restaurants. Furthermore, phone operators do not work for 24 hours a day and voicemails are one-directional exchanges with no value-add.

Secondly, bookings and individual guest preferences are either recorded in hard-copy reservation books or stored in the brains of individual staff. The loss of the handwritten records and the departure of employees typically create problems for restaurant operators.

Last but not least, there is nothing that is as desired as choice in the minds of consumers. Having to call all the targeted restaurants individually to check for the availability of tables puts a damper on customers’ plans even before the first dish is served. Similar to travel plans, consumers are looking for a destination website to meet all of their restaurant-booking needs.

OpenTable solved restaurant operators’ problems by providing services such as websites and mobile apps offering customers access to table availability data and its proprietary Electronic Reservation Book (“ERB”) solution, comprising software which is installed on a touchscreen computer system. According to the 2010 edition of the Deloitte & Touche Restaurant Industry Operations report, only 35% of restaurant operators’ costs are variable, suggesting that additional customers delivered through OpenTable’s platform and services add significantly to the bottom line through operating leverage.

Network effect beneficiary with strong recurring revenue

The market leader or first mover whose brand is synonymous with the products or services in question usually leverages its market position to grow even more rapidly, effectively keeping new entrants out of the market. As OpenTable expands its network, an increasing number of diners will be attracted to the wider variety of dining options through its websites and mobile apps; while more restaurants will be happy to join OpenTable’s network to reach out to a larger base of customers.

Using North America as an example, OpenTable’s customers are paying an one-time ERB installation fee that averages from $200 to $700, with a monthly subscription fee of $199. OpenTable also enjoys additional upside through a variable performance fee charged per diner seated through its online and mobile reservation platform. The results speak for themselves: OpenTable grew its revenue in every year since 2006.

Growth drivers

OpenTable still has significant growth prospects, both domestically and internationally. Management guided for U.S. and international revenue to grow by 21% and 58%, respectively, based on the lower end of its estimates for full-year fiscal 2013.

According to its most recent investor presentation, 15% of U.S. diners are seated through OpenTable’s reservation systems, with 36% of reservation-taking restaurants installing its systems. In contrast, half of reservation-taking restaurants in its flagship market, San Francisco, install OpenTable’s systems, with 35% of the city’s diners seated through its systems. This implies significant room for further penetration and growth.

Its largest international market, the U.K. shows similar statistics. Only 3% of diners and slightly more than one-quarter of reservation-taking restaurants are using OpenTable’s reservation systems. OpenTable acquired a toptable.com, a leading U.K. restaurant reservation site in 2010, and integrated its real-time reservation availability technology with toptable.com’s technology platform in 2012. I am positive on OpenTable on further expanding its U.K. presence.

Peer comparison

OpenTable’s peers include Zillow (NASDAQ: Z) and HomeAway (NASDAQ: AWAY).

Zillow is the leading online real estate portal, providing property-related information and property listings to its users. It registered record revenue of $39.0 million for the first quarter of fiscal 2013, representing a 71% year-over-year increase on the back of 52 million monthly unique users on mobile and web in April, the highest in its history.

Going forward, one key growth area for Zillow is its new rental-listings business. Zillow currently has more than 600,000 rental listings, equivalent to about 7 million rentals. This is small relative to the entire market opportunity based on management estimates for demand from 100 million U.S. renters. I am negative on Zillow, given its exposure to the cyclical U.S. residential housing market and short profitability track record. Zillow only became profitable in 2011; while OpenTable has been in the black for the past four consecutive fiscal years.

HomeAway is a large global online marketplace for vacation rental homes. Similar to OpenTable, HomeAway operates on a subscription-based business model with recurring revenue accounting for about 85% of fiscal 2012 turnover and high renewal rates above 70%. Based on the lower end of management guidance, full- year fiscal 2013 revenue and EBITDA are expected to increase by 20% and 21%, respectively.

Despite this, I am not going to invest in HomeAway because of the highly fragmented nature of the vacation rental industry.  There are literally thousands of vacation rental listing websites competing directly with HomeAway, and the industry is too exposed to discretionary consumer spending.

Conclusion

OpenTable benefits from network economies and boasts of strong recurring revenue from its huge network of more than 27,000 restaurants globally. Although a forward P/E of 28 might seem expensive on an absolute basis, OpenTable is undervalued on a relative basis compared with its online peers valued at above 30 times forward P/E.

In addition, it delivered an impressive trailing-12 month ROE of 18.1%, which will put many of its peers to shame. I will recommend OpenTable as an investment candidate, which is a proxy of increasing penetration rates of online and mobile reservation systems like that of OpenTable.

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Mark Lin has no position in any stocks mentioned. The Motley Fool recommends HomeAway, OpenTable, and Zillow. The Motley Fool owns shares of HomeAway and Zillow. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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