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Prospects for OpenTable: Is This Online Restaurant Reservation Business Faltering?

November 13, 2012
Investing, Investments
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By Jonathan Hwa, Guest Contributor.

With average but not spectacular earnings released last Thursday, OpenTable (OPEN) seems to have lost its growth spark as of late, with a near flat YTD return. Although it is still growing with a 26% year-over-year increase in seated diners, investors have become concerned with deceleration in overall installed restaurant and seated diner trends.

What should investors be thinking about, and do they need to worry?

Bulls argue that OpenTable’s operating leverage and increasing average revenue per diner reservation permit strong monetization of any incremental growth from this point forward. However, this view is contingent on steady or increasing operating margins that could easily be eroded by growing competition in this highly profitable internet bookings space.

Examining Intel before and after AMD’s rapid growth near the turn of the century gives us insight regarding the vulnerability of the market leader’s margins.

Intel (INTC), founded in 1968, quickly became the primary hardware supplier of the entire PC industry, with its Pentium brand as a household name. However, after 2000, Advanced Micro Devices (AMD) gained a foothold initially in the low- and middle-range markets and eventually across Intel’s entire product spectrum. From 1997 through 2003, AMD revenue growth was virtually synonymous with a decrease in Intel’s operating margins of similar magnitude.

As a result of AMD’s successful entry into the market, Intel’s operating margins tumbled from 30.8% to 8.5%, while AMD expanded margins from -0.9% to 12.5% in 2000 and 2001 respectively. Intel’s margins never fully recovered.

While Intel and AMD are in a very different market than OpenTable and other pure internet companies, we can draw some parallels from this case. Like Intel, OpenTable is the virtually undisputed leader in its space. While Livebookings is a similarly-sized competitor in Europe, OpenTable holds a vast lead in installed restaurants over any of its much smaller competitors in North America, such as Urbanspoon, UReserv, or SeatMe (OpenTable has 25,000 installed restaurants compared to Urbanspoon’s 1,300).

However, also similar to Intel’s case, there is room for a low-priced competitor to take market share.

Pricing Comparison

System

Installation

Base Monthly
Subscription

Avg. Fee
Per Diner

Cost Over
1 Year

Cost Over
3 Years

OpenTable

$1,000

$199

$0.74

$7,813

$21,439

Urbanspoon

$0

$200

$0.65

$6,300

$18,900

SeatMe

$0

$99

$0.00

$1,188

$3,564

UReserv

$0

$30

$0.00

$360

$1,080

*with 65% of reservations being made through booking website and 500 reservations per month

 

OpenTable’s system is priced at a premium due to their industry-leading network of restaurants and diners. As the above comparison shows, new startups like SeatMe and UReserv are trying to capitalize on the low-priced market opportunity created by this. However, without the resources and brand recognition to scale significantly, it would take a competitor on the scale of Google (GOOG) to put a dent in OpenTable’s operations.

So what happens to OpenTable if a company like Google decides to enter the market? Given Google’s resources, it’s not hard to imagine them building a system as good as if not better than OpenTable’s and then selling it at cost to rapidly build critical mass. As suggested by the case of Intel and AMD, OpenTable’s pricing and margins would decrease drastically as it is forced to compete with a large company willing to burn through cash.

Using OpenTable’s FY 2011 numbers, we can estimate the effect of lower pricing on operating margins (specific to North America) as compared to the latest revenue metrics from Q3 2012 (represented by the highlighted cell).

With operating margins below 10% considered to be dangerously low, you can see that OpenTable quickly drops into questionable profitability if forced to compete heavily on price. If Google were to introduce a product of equal quality and price it anywhere close to SeatMe or UReserv, OpenTable would face the choice of either becoming unprofitable or losing installed restaurants, both of which would kill its growth valuation. For a growth stock, this should certainly pose a looming doubt for any investor.

While it’s impossible to say for sure whether or not Google will want to dabble in the online bookings space (although its $151 million acquisition of Zagat does give us a clue), what we can say for sure is that competition is inevitable. With such an attractive business model and impressive margins, it is not a question of if but rather when OpenTable will have to fight for its life against a Google, Facebook, Microsoft, or Apple. OpenTable’s stock might not fall tomorrow, but investors holding the stock for the long-run may as well be tied to an anchor.