Late last week, the online travel giant Priceline (NASDAQ:PCLN) announced its decision to acquire the restaurant reservation leader OpenTable (NASDAQ:OPEN) in an all-cash deal for $2.6 billion.  The offer price of $103 a share was a good 47% higher than the $70 figure OpenTable closed at last Thursday, June 12, The sharp premium valuation will suggest to some that there were possibly alternative bids, suggested as well as investors lapped up the shares to help them close at almost $104.50 — above the bid and at a level the stock was last seen at in April 2011. The premium over Priceline’s offer price indicates that investors are optimistic about a competing bid by other big players in the industry.
Our analysis of OpenTable values the company at roughly $1.65 billion — close to its market cap before Priceline announced the acquisition deal. So is Priceline really justified in paying a $1-billion premium for OpenTable? As we detail in this article, Priceline can justify the large premium of the bid, even as it has to integrate OpenTable’s business with its own.
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OpenTable is the undisputed leader in the online restaurant reservation industry, with the company reporting a restaurant customer base of 31,583 at the end of Q1 2014. The company seated a little less than 47 million diners at these restaurants in the first three months of the year, with 90% of them in North American restaurants. Data compiled by us for every quarter since Q1 2008 shows that OpenTable has seated almost 570 million diners worldwide in the last seven years, with the number of diners growing at an average of 35% each year.
But OpenTable’s remarkable growth story isn’t one without problems. The biggest problem the company has faced over the last few years has been a steady increase in costs as it struggles to replicate its success in North America in other international markets – primarily U.K., Germany and Japan – as well as to increase its share of the North American market by extending its reach to regions outside major metropolitan areas where it already has a strong grip. This shortfall is what Priceline would be looking to bridge in order to unlock huge value as a part of the deal with OpenTable.
Priceline’s operations are huge in scale compared to OpenTable’s. To put things in perspective, Priceline reported a pre-tax income of $2.4 billion from total revenues of $6.8 billion in 2013 while OpenTable’s figures for the period were $46 million and $190 million respectively. While Priceline employs the services of 9,000 employees, OpenTable’s headcount was 664 at the end of Q1 2014. But the most important factor is that Priceline’s operations in international markets account for more than 90% of its income, whereas OpenTable’s international business is yet to report a quarterly profit.
Even though Priceline intends to operate OpenTable as an independent business under its existing management — a strategy it has successfully implemented for its acquisitions of Booking.com and Kayak over the years — it will look to benefit from the cost synergies that exist for OpenTable’s restaurant reservation business from its existing workforce overseas. Priceline’s CEO, Darren Huston, indicates this quite clearly by mentioning that the company aims to help “the OpenTable team accelerate their global expansion.” The number of OpenTable’s restaurant customers outside North America has remained around 7,700 for the last six quarters, and we currently forecast a 5% annual growth in this figure over the future. But Priceline’s strong global presence will help international growth jump to between 15-20% annually in coming years. Making this change in the chart above shows that this boosts our price estimate for OpenTable by roughly 20% – an increase of about $350 million to its total value.
Also, as Priceline integrates OpenTable’s technology with its own offerings, it should cut millions in the latter’s operating costs – especially in support-related expenses which represent the biggest chunk of OpenTable’s quarterly expenses. We currently estimate that the company’s operating margins will only see minor improvements over the years to come, but the Priceline deal can potentially see margins rise to above 80% by the end of our forecast period as operating costs grow at a considerably slower rate than revenues. This produces a 15% improvement to our price estimate, or a $250 million increase in value.
At the same time, marketing expenses will also be considerably lower for OpenTable, both internationally and in the U.S., as Priceline’s existing sales & marketing workforce will most likely be entrusted with these activities for OpenTable too. While OpenTable will continue to advertise its own products separately, the ensuing reduction in headcount should shrink SG&A expenses to no more than 40% of gross profits by the end of our forecast period compared to the figure of 60% we estimate in the chart below. This results in what is by far the most significant upside potential for OpenTable’s share value as a result of this deal. The 45% upside that this change to the chart below represents means that OpenTable’s value could increase by more than $700 million from SG&A cost benefits.
Taken together, the three factors we detail above, increase OpenTable’s value by around $1.3 billion in Priceline’s hands. So the latter stands to gain, even at the rich valuation of the $2.6 billion bid. And this estimated value for OpenTable does not even include the potential for faster growth in the number of subscribing restaurants from North America, faster diner growth as Priceline adds restaurant reservations as a part of vacation packages, or the higher cross-sell opportunities provided by OpenTable to Priceline’s advertising platform. Because of this, we believe the popular travel deal-broker has got itself a really good deal.Notes:
- The Priceline Group Agrees to Acquire OpenTable, Inc., Priceline Press Releases, Jun 13 2014 [↩]