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Why Priceline's $2.6 Billion Buy of OpenTable May Be a Bargain

Stocks in this article: OPENYELPGRUBGOOG

Prior to Friday's announcement, analysts were bullish on the stock. Telsey Advisory Group analyst James Cakmak had a 12-month price target of $91 for OpenTable, saying it makes sense for the company to begin spending money on advertising as it starts to roll out the next stage of what the dining experience is going to look like -- and that's mobile payments.

"The reason why I'm bullish on OpenTable most of all is because of this mobile payments opportunity, because what it's going to do is transform the way diners interact with servers during the checkout process," said Cakmak. "If there's a little bit of money behind it, I don't have a problem with that."

The payments system could, of course, improve convenience for diners, who would no longer have to wait for the server to bring the bill. They might also like the efficiency of being able to manage the entire restaurant transactions process from one location, from reservations all the way down to payments. Furthermore, it would provide the opportunity to split the check if diners are going to a restaurant as a group.

That could help drive OpenTable app downloads for those who want that functionality, thereby fostering user engagement. The ease of the payments system could also speed up table turnovers for the reservation-taking restaurants, which would help them run their businesses more efficiently especially during peak lunch hours.

With North America EBITDA margins greater than 50% and no imminent threat to its strong brand name and powerful network of reservation-taking restaurants in the region, OpenTable's dominant competitive positioning and leadership in electronic booking looks very much secure despite losses internationally.

In recent months, there's been growing speculation that OpenTable's market share is under threat by cheaper electronic booking systems, as punctuated by Yelp's (YELP) acquisition of SeatMe and the May launch of the no-fee-required Yelp Reservations service incorporating SeatMe technology. Currently OpenTable charges restaurants a monthly subscription fee of $199, a one-time installation fee of $650 and recurring coverage charges of $1 and $2.50 per cover. By comparison, Yelp's SeatMe charges a $99 monthly subscription fee with no installation nor charge-per-diner fees.

While Yelp itself has publicly touted the cost benefits of its booking services over OpenTable's, it's becoming a well-known secret that Yelp is not trying to take over or encroach on OpenTable's territory. The two remain strong allies. OpenTable's main focus has been on the 35,000 core reservation-taking restaurants in North America; the very reservation-heavy ones that need servicing. With SeatMe and Yelp Reservations, Yelp has been going after the longer-tail or non-core reservation-taking restaurants and just providing the booking capability as an additional service for advertising on its platform.

Yelp's key focus continues to be forging relationships with every local service and product vertical out there. At its core, it remains a broker between consumers and businesses including OpenTable, without the end-to-end solution of actually servicing the businesses.

"When you think about the low-cost competition, you know the guys that can undercut them on price, you have to ask yourself, if you're a restaurant, where are the diners?," says Cakmak. "The diners are with OpenTable."

OpenTable still has a great amount of seated diner penetration potential, thus minimizing the correlation between economic headwinds and consumer health to the outlook of the company. Even as the established leader in restaurant bookings in North America, it's only penetrated 19% of North America market. In the U.K., it's only entered 5% of the market. Aside from Yelp, the other players that have been moving into the space include Livebookings, Eveve, and Groupon Reserve, all of which Morningstar consumer equity strategist R. J. Hottovy says have not created much of a dent in North America.

One caveat that comes with the growth outlook for OpenTable is more and more people are using restaurant-delivery services such as GrubHub (GRUB), which could eventually divert traffic away from restaurants. "That's not going to be good for OpenTable," comments Hottovy.

The other caveat is the risk of slow mobile payments adoption. That could happen for a number of reasons: There's a lot of competition in the mobile wallet space, including from players such as ISIS, Google (GOOG) Wallet and MCX. Also, restaurants may view the presentation of the check as part of the service experience and a chance to upsell, and therefore be reluctant to join OpenTable's mobile payments plan. Furthermore, processing fees for the mobile payment options are higher, and it remains to be seen whether OpenTable would be able to achieve enough scale to negotiate them lower. Bradley Safalow, the founder and CEO of PAA Research, said OpenTable's mobile payments initiative is "a classic solution without a problem."

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-- Written by Andrea Tse in New York

Follow @AndreaTTse

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