Last week, I was surfing the internet and I came across Google Maps (GOOG). The website informed me that it had a new version and it urged me to test it. Since curiosity got the best of me, I decided to give it a shot. To my surprise, this was a well-done project that has the potential to eat Yelp's (YELP) lunch in the long term.
Once I clicked on the link Google provided me, it asked me to enter a search query. The website's suggested query was "sushi in Boston" so I used that one. Once you make the search, the website gives you two options to pick from: top reviewers and your circles. Top reviewers option refers to the most active and the best reviewers using Google's network. Your circles option refers to one's friends in Google's network. Basically, when you are searching for sushi in Boston, Google lets you decide whether you will make your decision based on reviews of your friends or Google's top reviewers in Boston.
Once you click on one of the options (I picked "top reviewers") it showed me a list of places that offer sushi on the map, along with their ratings. This is the exact same thing Yelp does, except that Yelp's mapping system is not as advanced as Google's.
For reviews, Google currently uses its Google+ network, Zagat and several other sources. Users are also able to add their own reviews after conducting a search on the map and locating a business. Basically, Google offers everything Yelp offers, and then some more.
After passing MapQuest and Yahoo Maps in the mid-2000s, Google Maps became a major force in online mapping. In fact, more than two-thirds of internet users utilize Google Maps for their mapping needs and this is not limited to the PC market either. Even in mobile and tablet markets, Google Maps continues to be dominant. In fact, according to comScore, Google Maps is not only the most popular mapping app, but it is also one of the most popular apps across everything. Currently, Google Maps is being used in 46% of all mobile devices.
After being heavily criticized over having many different bugs, Apple (AAPL) improved its mapping application big time and it competes with Google Maps for market share of people who use iOS as their mobile operating system. Interestingly, Apple's homegrown mapping application utilizes Yelp reviews when someone searches for a local business using it. As Apple Maps' users continue to increase (estimated to around 35 million compared to 60 million Google Maps users), which helped Yelp's growth greatly. Now that Google is in the game, things might change for Yelp.
Yelp is currently priced for perfection and beyond. Investors expect Yelp to grow tremendously over the next several years. While the company continues to grow rapidly on year-to-year basis, we see a different story after looking at quarter-to-quarter growth, which might suggest that the company's growth is slowing down. For example, last quarter, Yelp grew its revenues to $61.18 million. If we look at year-to-year growth, we see a growth rate as high as 68.22% (up from $36.37 million). On the other hand, if we look at the company's quarter-to-quarter growth, we see 11.20%. Annualizing this rate would give us 57.35% as opposed to 68.22%.
Since the company doesn't really have positive earnings we will have to value the company using its revenues. Having said that, in the last 4 quarters, Yelp generated $203.49 million in revenues. If the company can grow its earnings by 50% every year (which is a very optimistic scenario and unlikely to happen), it will generate $3.48 billion in revenues by 2020. If we apply a 10% discount rate and value the company at 3 times its revenues, we are looking at about $4.8 billion of valuation for Yelp, which comes down to $72 per share. Keep in mind that this is the most optimistic scenario and this assumes zero dilution. This also assumes that Yelp will be profitable at some point in time.
A more realistic scenario would say that Yelp's annual growth will be 50% for the next couple years but it will fall to a 30-35% range after 2015 and to 15-20% range towards 2020. Given that Yelp is much more volatile than the average stock, I would also set the discount rate at 15-20% rather than 10%. This would value Yelp at much lower than $50 (closer to high $30s or low $40s).
There is really no way to justify Yelp's current share price. The company has no earnings, its revenue growth is slowing down, it is facing increasing amount of competition, it keeps diluting its shares and the business model doesn't look very sustainable. Yelp's business is very easy to copy and I don't really see how it is that much different than the internet companies we saw during the dotcom bubble of late 1990s.
Additional disclosure: I'm long both calls and puts of YELP.