New breed of IPO's - Who's really making money?

I find the new breed of IPO’s very concerning. Open Table is one of the early New Breed IPO’s that came public in May of 2009. In March of 2010 the stock took off to new highs and just kept running. In fact, it started to take off so rapidly any short seller that got in the way got rolled like the guy walking with his head up in Hell’s Kitchen.

The stock was relentlessly going up, In fact, I started to call it Krispy Kreme. It resembled it (stock wise) in so many ways. However if someone took the time to look at the industry and just talk to a few restaurant owners one could learn what a snake’s pit this stock was in.

For one, the restaurant owners used Open Table begrudgingly. They hated the console, they hated the large fees and the service was at times subpar. Yet Open Table had little competition, from bumbling competitors with similar models to UrbanSpoon not recognizing what a large market they really could take advantage of.

So as friends and associates asked me what the stock charts said, I told them there will be a time to short it and there would be a glaring first sign..

The First Sign was utter dominance and emergence of Groupon and the daily deals. Their customers that were addicted to the daily deals, were also not the type to make reservations. For a number of reasons the two did not co-exist. Flavor of Seattle, noticed that trend and made a note of that. The correlation was powerful. It’s what led them to beta test and suggest that this demographic was ready in 2010 for “The deal on the run.” Spontaneous action is looked upon as fun. It was like a surprise. It also coincided with the explosion of the Happy Hour scene throughout the country.

Secondly , I said wait for their first disappointing earnings report. That came on May 4th of 2010. It was exactly what I had thought. Restaurant owners were balking at the fees, the Groupons were making inroads, the direct competitors were offering better tools at much lower prices and Social Media was taking off. Overall, the restaurant owners had more freedom and were being “truly empowered” by other tools. Add to all this, the CFO was now becoming the CEO and President. – Holy Cow!

Finally, The Death Knell, in late May a report came out that the insiders (executives) were selling the stock rapidly. Here are some of the quotes:

“Executives have been cashing out their tabs, selling nearly 286,000 shares in the online restaurant-reservation company since the stock hit an all-time high in late April.”

“Seven insiders, including the company's chief executive and chief financial officer, have sold shares since the April 25 all-time high of $118.66.”

OpenTable Director Thomas Layton - “Layton sold 237,550 shares in two transactions for about $22.5 million.”

Needless to say, the stock started a downward freefall. However, what often happens is that these type of stocks have a way of bouncing back up – once. That’s the time to short the stock.

I told friends and associates short this stock at 90. It is currently at 52. They also asked me when to cover the short position. I told them at the 90% level from the high of 118. Yes I believe this is a $12 stock. At $52 (2/3/2012), the stock was trading at a PE of 65!!

So is this post just about stock trading? No it’s also about lessons Startup Founders and Investors need to understand.

1. Listen to your customers. If Open Table listened to their customers – they would not have left the door wide open to their competitors.

2. Understand the speed of technology. Today’s speed of technology can compress margins and or make your technology obsolete – IN A HURRY.

3. Focus on making your product or service the best it can be - Priority #1 (but don’t ignore your competition.)

4. Understand what your strengths are – If it’s not a technological advantage – then focus on better service, customer loyalty and pricing.

5. Business Development – Open Table could have done a much better job of building joint development models with other industry partners – instead of going at it alone.

6. Don’t be afraid to Sell. Selling a business that you built which is worth 20, 50 or 100 million is always better than getting wiped out. Unless ofcourse you can sustain it to sell as an IPO. – Wink Wink

If you are an investor of a Consumer Internet Product/Service:

1. Do channel checks or use the product.

2. Check the books of the company – Look for high levels of debt.

3. Always check the insider selling transactions. (They’ll always say it’s their time to sell but look at how much stock they still own and the timing.)

4. Be careful and cautious of low volume stocks – you can get wiped out in a week on a freefall.

5. Study the competition and use their product/service as well.

6. If the company has 3 good quarters and the 4th is disappointing – it’s usually a sign of a trend and not an aberration. Evaluate carefully.

7. Don’t ever believe the hype.