OpenTable: Blodget's analysis flawed

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In a recent post about OpenTable's recent IPO, BusinessInsider CEO and former sell-side analyst Henry Blodget takes a straight valuation approach to the company. He concludes that growth of U.S. revenues is already slowing and that the stock is priced for perfection with forward price-to-earnings multiples in the 65x range for 2010 earnings.

If OpenTable (OPEN) were a run of the mill software or internet business, Blodget would be right. What he fails to account for is that OpenTable is actually a "network effect" business -- and U.S. growth could soar in the near future.

Network effect businesses become exponentially more valuable and profitable with each additional user. The classic example is the fax machine. One person with a fax machine is useless. Thousands of people with fax machines are slightly better. Millions of people with fax machines make it invaluable.

OpenTable has a similar dynamic but in an dual fashion. If one restaurant is on OpenTable, no one cares. If thousands or even tens of thousands are on, then it becomes fairly useful in highly populated urban areas (where the big concentrations are right now). If the majority of restaurants in major metro areas go onto OpenTable, then the network becomes far more valuable and sticky both to the restaurants and to the diners, who will get a one-stop shop for food reservations, reviews, etc. Of course, that's a big if and OpenTable hasn't gotten there yet.

But if it does, then revenue could soar as the service becomes a dominant access gateway for diners, and restaurants that fail to participate are at a demonstrable disadvantage. This would becoming a self-enforcing cycle. Granted, restaurants will always be able to survive without OpenTable.

But the real question is, will OpenTable be able to demonstrate that it can drive significant profits to customers in this brutal business. If the answer is yes, then Blodget's revenue growth assumptions will go by the wayside as the network effect kicks in and having an OpenTable listing becomes more like having a fax machine. That doesn't mean the stock still isn't overpriced, but it could mean that figuring out a correct valuation for the company is far less straightforward.

Alex Salkever is the Director of Research at Piqqem.com, a stock prediction community powered by the Wisdom of Crowds.
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