It’s Becoming More Expensive for OpenTable to Maintain its Lead

OpenTable (NASDAQ:OPEN) is at the top of its game. As the leading provider of free and real-time online restaurant reservations, the company is comfortably ahead of its competitors like Urbanspoon, owned by IAC/InterActiveCorp (NASDAQ:IACI) and UK-based companies liveRES Ltd and Livebookings Ltd. It also seems to have hit the right note with its decision to take Groupon head-on by selling third-party restaurants coupons through its website.

While the company has repeatedly surpassed investors’ high expectations, maintaining this trend is going to get a bit more expensive. OpenTable’s focus on markets outside North America is the most logical course of action for the long run. But this also means that the company will need to spend significantly in the years to come – before the strategy of geographical diversification can generate much upside.

We currently maintain a $94.90 price estimate for OpenTable, at a premium of roughly 5% to market price.

OpenTable has already seen a significant increase in its expenses…

The expenses incurred by OpenTable are reported under the categories of technology, operations, & support, sales & marketing, and general & administrative. Since the technology and operations & support costs are direct expenses for the company, we have included this as a part of the company’s gross profit margin in our analysis, while the other two cost components have been combined as sales, general & administrative (SG&A) expenses.

OpenTable’s direct and indirect expenses increased by only 10% in 2009, although revenues shot up by 25%. This is a fitting trend for companies operating in the internet industry. In 2010, after the acquisition of toptable.com, top-line revenues grew by 40%, accompanied by a larger-than-expected 25% increase in expenses.

… but we think this could continue in the years to come

We believe that while toptable.com did contribute to a bulk of the increase in expenses – more particularly the indirect expenses – an important factor was a disproportionate increase in sales & marketing expenses.

OpenTable’s marketing model relies on a direct sales force of regional account executives and sales representatives as well as a team of inside sales representatives. With increasing competition on OpenTable’s home turf from newer players – notably Urbanspoon – marketing spend has shot up as part of an effort to retain existing customers.

Also, the company’s moves into newer markets will require expenditures to establish a sizable workforce at each location. On top of that, in order to capture the growth opportunity from offering third-party coupons (similar to Groupon’s business model), OpenTable will need to allocate a notable portion of its workforce to this product segment.

The increase in marketing expenses is captured in our forecast for SG&A expense as a percentage of gross profit.

SG&A costs have declined in the recent past, dropping below 70% of gross profit in 2010. We forecast that this value will continue its decline, to about 57% of gross profit in 2011, and settle around 42% by the end of our forecast period. However, if our forecasts prove aggressive, and SG&A expenses as a percentage of gross profit hit 64% in 2011 and only 50% by the end of our forecast period, it would imply 10% downside to our $94.90 price estimate for OpenTable. This would put our number just above $85.

See our full analysis and $94.90 price estimate for OpenTable