It has been a slow year for IPOs so far, but recently a few offerings have caught Wall Street’s attention.  Open Table, Inc. (OPEN) was an extremely successful offering with the stock issued to investors at $20, only to trade as high as $35.50 during its first day of trading.  OPEN has settled back down to a more modest 40% gain currently but the outlook may be difficult for this consumer driven stock.

Open Table is built on a business model that essentially brokers between diners and local restaurants.  The restaurant business has relied primarily on word-of-mouth referrals and print advertising.  Open Table, however, attempts to provide an online medium for diners to select where they want to eat, to review options within their community, and to book reservations even restaurants which are typically hard to get into.

The company collects revenue from three primary fee categories:

1. Installation Fee – Restaurants pay to install Open Table’s software and to train employees on the system
2. Monthly Subscription Fee – The restaurants also pay monthly to keep the system operating
3. Individual Diner Fee – Open Table also collects a fee for every diner that registers for a meal through the platform.

Something about this setup reminds me of the old “dot com” days when companies could come public with very little (or no) earnings and still collect a large premium for their stock.  While Open Table was posting a profit in 2007, the company actually lost money last year as the economic weakness caused weakness in the dine out business.  To its credit, OPEN has been able to grow revenues quarter after quarter, but profitability eventually is the key metric which determines the stock price.

Currently the company operates in Chicago, New York City, San Francisco, and Washington DC.  Adding new markets will be key to the company’s growth, and yet that will be difficult as consumer trends certainly aren’t favorable to the dine out business.  At ZachStocks, we have mentioned the growing trend in the US towards becoming a nation of savers.  That trend could make it very difficult for luxury businesses such as high-end restaurants, and companies like OPEN who support the industry.

Looking at the terms of the deal, the IPO priced at $20 while the underwriters were able to keep $1.40 of that price.  Merrill Lynch was the lead on the deal and while Merrill still has the largest base of retail clients, its status as a quality underwriter is less prominent than it was 18 months ago.  The shares were actually sold both by the company as well as private shareholders.  The 1.57 million shares sold by Open Table will raise roughly $26.3 million which will be used for “general corporate purposes.”  OPEN currently has no debt outstanding, which leaves it with plenty of options for financing growth.

Despite my respect for the innovation of this new business model, and the success OPEN has had in building a strong presence, I think the stock is very vulnerable to a decline.  There are still more than 19 million shares held by insiders and private investors, many of which will eventually find their way to the market creating selling pressure.  Macro economic issues create a strong headwind for the business, and earnings have yet to come anywhere close to fundamentally supporting the stock price.

It may be difficult to borrow shares today, but in the near future I expect OPEN to offer a great short opportunity.  If the stock fell to a price of $12, short sellers would make more than 50% on their trade.  And at a price of $12, the stock would still carry a 20 multiple compared to 2007 – its most successful year.  Please treat this position with caution as volatility will be high.

FD: Author has no position in OPEN