Once upon a time when the Internet was new, a chat room on AOL would have been the closest thing to "Social Media". Then suddenly there came a promising website called classmates.com. The web domain was user friendly, easy to remember and made it clear what the visitor should expect.
Over a period of years from the late 1990s into the middle 2000s, Classmates grew at a steady pace. It got to a point where one could find many of their old friends on there. The members were easily in the millions, if not tens of millions and they were getting close to achieving the state of "critical mass" important for a company to obtain web dominance.
Everything seemed to be going well and the future looked favorable for Classmates. But in the background, over a period of years two companies known as MySpace and Facebook (FB) were gradually taking hold. Initially these young companies seemed to appeal more to the teenagers, college kids and celebrities. We know the rest of the story with Facebook winning the battle for critical mass and of course MySpace faded into obscurity. But little has been spoken about what Facebook did to Classmates. In reality, Classmates had a head start on Facebook and MySpace. When I think about MySpace the phrase "I could have been a contender" comes to mind. If they had a slightly different business model, they might have had the $80 billion IPO instead of Zuckerberg. If you never used it, Classmates had many similar capabilities of early social media. What did them in was their closed system that allowed users to post limited bios and photos but required users to become subscribing members if they wanted to have any meaningful communication with their friends.
With 38 million registered users they were on their way to being dominant but this subscription model of theirs proved far inferior to the Facebook model in the long run. Once Facebook took off it was all over for Classmates. They quickly achieved irrelevance and sold off to United Online Inc. (UNTD), for a meager $100 million.
Investors can learn from past strategic blunders and profit from them when we see similar strategies employed by companies in various industries with similar circumstances. The other important ingredient is that the company being shorted for this strategic error must be over-valued with a market price that defies basic sense.
Right now, one such opportunity can be found in the field of Consumer Reviews. The highly publicized company Angie's List, Inc. (ANGI) , which engages in collections of consumer reviews on local service providers ranging from home improvement to health care is in a position similar to that of Classmates.com when you compare the formidable threat posed by free social media rising star Yelp (YELP) and the billion user strong giant that clobbered Classmates.com years ago-Facebook.
YELP is in the early stages toward reaching critical mass. Large and growing numbers of reviews in a wider range of sectors available free of charge -is probably preferable to hundreds of millions of consumers over the more esoteric pay subscription model. Angie's List is trapped because their sales pitch from day one has been based upon their subscription model supposedly being more credible and if they switched to a free model, it would be Angie's List who would lose all credibility. To change course would require them to declare that they got it wrong and essentially start over from scratch.
The reason why the service of Classmates became obsolete was because the very simple service they offered-a way for classmates to find each other and reconnect-was one of many corollaries of Facebook's application. Even though Facebook didn't necessarily set out to take down Classmates, they became collateral damage. That is obvious because by virtue of near 20% of the global population and the majority of western civilization having an account on Facebook, consumers had a much higher probability of finding their former classmates from high school and college on Facebook. Who in their right mind would pay Classmates $50 a year or more to find less people than they could on Facebook besides perhaps the people who still pay AOL a monthly fee for dial up?
Because Yelp targets additional and much larger sectors than does Angie's List, I doubt they feel threatened by Angie's. Their main competition would be Facebook and OpenTable Inc, (OPEN) which is now partnering with Facebook. But Angie's List has every reason to expect to be clobbered by Yelp. Angie's doesn't have a bad model. It's just that Yelp, like Facebook over Classmates, has a -better- model.
The crux of this thesis is basic business sense and the obvious problems for Angie's should be self-evident at the macro and philosophical level. My past analysis on Angie's brought me to the conclusion that this company may survive with its little niche of possibly loyal, paying subscribers (time will tell how loyal after YELP and FB further dominate this market), but it should not warrant a market cap anywhere near the current $1.3-$1.6 billion market cap.
I have read some columns questioning the accounting methodology that put a $0 market cap prediction on them but I am not a forensic accountant and will leave that speculation to others. My best case scenario for Angie's List projects a market cap of $200-$300 million based upon the fact that there are approximately 313 million people in the U.S. and 24% of them are under the age of 18 according to U.S. census data. If one out of 10 of the remaining Americans pay to subscribe to such a service, that makes a total pie of around 24 million potential-paying-subscribers. Ask 10 random people as often as you like and see if better than an average of 1 out of 10 would pay for such a subscription year after year in this economy. Angie's is also bringing in revenue by selling ads to vendors and there are accusations of conflicts of interest with that. Nevertheless, when you have such a limited number of potential subscribers, that growth will be limited.
Angie's List has been in existence since 1995 and just recently reached the 2 million subscriber mark last quarter. Contrast that with Yelp's numbers and you can see a tremendous difference in potential future revenue. According to Yelp's CFO Robert J. Krolik on their Q2 conference call, "we added over 3.4 million reviews in the quarter." That my friends is a large number of new reviews that give users a great deal of feedback for due diligence. Krolik continued, "our average monthly unique visitors grew 38% year-over-year to roughly 108 million . Approximately 32% of these uniques are accessing our mobile site." (bold emphasis added)
With the death of the PC and more consumers using mobile, they are growing substantially in all of the right places. The average monthly unique users are roughly 108 million??? Compare that with Angie's List's total of approximately 2 million paying subscribers and you can see why Yelp may be to Angie's List what Facebook was to Classmates.com
The question left is what will Facebook be to Yelp? I believe Yelp is close to reaching critical mass in its unique niche that happens to be a trillion plus market cap when you add up the numbers elucidated by the National Restaurant Association's website and factor in the media and entertainment industry estimated to be $2 trillion (globally).
I believe that Facebook has many characteristics that portend favorably to the consumer review industry but I do not believe they will substantially quell the growth of Yelp. The parallel I would draw between Facebook and Yelp would be more akin to the competitive situation between Netflix and Amazon. I believe Yelp like Netflix (NFLX) will continually grow at an impressive rate because they were built to do one thing and they both do it very well in their respective niches. Amazon (AMZN) like Facebook has a much larger scope but they will certainly find some success.
To summarize some key factors that make Yelp an attractive long term buy:
- There is plenty of growth ahead while the stock sits at a $3.6 billion market cap while serving a trillion dollar plus industry.
- There is plenty of business to go around for both Yelp and Facebook.
- They both are growing well and siphoning advertising revenue from Google (NASDAQ: GOOG) because Google search doesn't seem to be as conducive to mobile advertising and mobile may be leveling the playing field for these companies as Google's Q2 ad revenue declined by almost the same dollar figure that FB & Yelp's grew thanks to mobile ad revenue (anecdotal though it may be).
- Advertisers want eyeballs and Yelp is giving them that in spades along with fabulous conversion rates . According to Yelp's CEO Stoppelman in the 2Q conference call: Excerpt
We've long known that consumers are using Yelp to search for local businesses with the intent to spend money. And in the second quarter, a study recommissioned by Nielsen found that when consumers find a local business on Yelp, 89% make a purchase within a week. This confirms that consumers rely on our high-quality content, which, in turn, creates the reason merchants advertise on Yelp. Our product and engineering team is hard at work on new features that help businesses close the loop with our customers (bold emphasis added).
Last but not least I want to emphasize some points made here at SA in those valuable comments that ensue underneath these great columns. We had a nice dialogue under a good column written by one of my peers (about ANGI). You can see from the screen shot below that this comment came before YELP's surprise Q2 earnings announcement. This contains some additional thoughts on ANGI and addresses that popular "no barrier to entry" objection by YELP shorts.
I already closed out my short position in Angie's List back in July; so I have no interest in Angie's but am long both Facebook and Yelp. Channeling Obi Wan Kenobi, let me help those who are looking for a short sale opportunity in the Consumer Review sector: YELP is Not The Short You're Looking For (Hint: Short ANGI if you must short something in this sector).
Additional disclosure: I closed out my short position in Angie's List in July and no longer have any financial interest in ANGI.