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OpenTable and Yelp Inc Shaping the Restaurant Industry

Yelp Inc (NYSE:YELP), the user-generated review Web site connecting people with local businesses, and OpenTable Inc (NASDAQ:OPEN),the restaurant reservation site, are reshaping the approach consumers take in selecting a restaurant to eat at. Believe it or not, Yelp ratings have a really strong influence on whether or not a restaurant succeeds in one of the hardest industries to survive in. Two Berkeley economists found through researching 328 San Francisco restaurants that a half-star improvement on Yelp’s 5-star rating makes a restaurant 30-49% more likely that a restaurant will sell out its evening seats. The study also found that the movement from 3 stars to 3.5 stars increased a restaurant’s chance of selling out during prime dining times from 13% to 34%. Moving from 3.5 stars to 4 stars increased the chance of selling out during prime dining by 19 percentage points. Until a few years ago, despite the wealth of restaurant information found on the internet, the ability to make reservations online was largely missing. OpenTable provides an efficient solution for restaurants to automate their reservation and simplify life for customers. Combining these two sites, a customer can check, review, view a menu, and make a reservation without picking up the phone or leaving their chair.

Yelp Inc (NYSE:YELP)

D.E. Shaw is the largest shareholder of Yelp common stock. Yelp isn’t very popular among hedge funds. The 400 hedge funds in our database have an aggregate long position of $3 million in the company. Robert Pitts, hedge fund manager of Steadfast Capital Management, is the largest hedge fund holder of OpenTable. The fund owns 1.3 million shares of OpenTable, consisting of 1.84% of the fund’s 13F portfolio. Valiant Capital and Brookside Capital are also among the hedge funds with large positions in the stock. Billionaire Israel Englander initiated a new small position in the company recently as well (see Englander’s new stock picks).

Hedge fund managers clearly have taken notice to these two tech start-ups, but why? The answer lies in the simplicity of the internet. The internet has given consumers the capability of transferring knowledge and information in a short time frame in nearly every developed area, and is accessible from stationary and mobile devices. The ease of surfing the web has changed consumer’s wants and needs, and businesses have been forced to adapt to stay competitive. In a tech driven environment, online services like Yelp and OpenTable have become second nature to many consumers. People have grown accustomed to companies like Inc. (NASDAW:AMZN), that allow customers to find the best fits for their wants and needs and have credible reviews to comfort their decisions. Now consumers are evaluating where they want to eat, and what better ways to make a decision than viewing user reviews on Yelp and checking for available seating on OpenTable.

You would think that restaurants would love giving customers the ability to check reviews, view menus, and reserve tables, but there are some who view it as an unnecessary cost. OpenTable comes at a monetary cost, which is $199 per month for each OpenTable terminal, plus one dollar per reservation. While some restaurants believe if they don’t have OpenTable they won’t be busy, other say that the service isn’t worth the 2-3% of revenue. Yelp is offered free to business owners, but can cost some companies their reputation. As the opening paragraph suggest, the star rating given to the restaurant often dictates the company’s success. There have been various issues of companies rating their competitors in hopes of stealing customers.

Angie’s List Inc (NASDAQ:ANGI) and Groupon Inc (NASDAQ:GRPN) are the best comparable for Yelp. Both Angie’s List and Groupon aren’t perfect matches, but Yelp’s services are similar to both of these companies in different ways. Like Groupon, Yelp is free and offers coupons, but Yelp’s review services expand further than Groupon’s. Angie’s List and Yelp both are primarily online rating services, but Angie’s List has a subscription charge and is focused on professional services, where Yelp is free and does not provide reviews for any specific service.  All three of these companies are in the introductory phase of their life cycles and are not profitable. Both Angie’s List and Groupon have been hit hard recently, their stock prices are down 42% and 80% respectively. Analysts view Yelp as having more potential than both comparables, Yelp is trading at 16.1 times sales, while the battered Angie’s List is currently trading at 3.6 times sales and the bruised Groupon is trading at only 1.1 times sales. We believe that the market is viewing Yelp as a site that has combined the core services that Groupon and Angie’s List offer, and we believe that Yelp will soon be the undisputed leader in online review and coupon services. Yelp’s broad range of services and growing number of users dwarf that of Groupon and Angie’s List. Yelp sales have grown 80% annually on average since 2010, and we forecast a 50% compound annual growth rate for the next five years. If Yelp can meet or beat our estimates, than their sky high P/S may actually be a bit low.

OpenTable is a unique company that does not have a good comparable that is publicly traded. Without another online restaurant reservation site, we compared OpenTable to the online travel reservation site Inc (NASDAQ:PCLN), and their closest competitor Expedia Inc (NASDAQ:EXPE). Investors are bidding up OpenTable and the company is trading at 6.9 times sales, while the online travel agent Priceline trades at 6.4 times sales, and Expedia trades at only 2 time sales. Year to date, the cheapest company in terms of P/S, Expedia, has delivered the largest return at 80%. Priceline and OpenTable have returned 27% and 12% respectively to investors thus far through 2012. We see various avenues of growth available for OpenTable, including emerging markets, and believe the company has an abundance of room available for growth in top and bottom line. With room for growth and displayed consumer acceptance in the United States, we believe that OpenTable is undervalued.

Both of these services have been the backbone of the transformation of how people find information on restaurants and make reservations. They both simplify consumer’s lives and can help restaurants draw people in to their business. These companies are market leaders in each of their niches, and have the capital and foundation necessary to continue to innovate. Although we agree that both services can be costly to a restaurants bottom line and reputation, we believe that both services are here to stay because they make customers lives easier. We believe that restaurants will have to conform to the customers desires, like the old saying goes “the customer is always right.”

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