- Yelp is an innovative and fast growing company with amazing potential for future growth. The valuation is priced for perfection and a best case scenario.
- There are many risks that threaten to slow Yelp's future growth considerably.
- Management thinks the company is massively overvalued, having sold 41% of its shares in the last 4 months.
- Even under the best case scenario, Yelp is likely to return just 13% CAGR over the next 10 years. The long-term stock market return is 9% CAGR, 11.1% with dividends.
- There are many high-yielding stocks with lower risk and volatility that are likely to outperform Yelp over the long run.
There is nothing quite like finding a fast growing tech stock to inspire dreams of easy money to get an investor's blood pumping. Although, history shows that often it is the slow, steady and boring dividend paying stocks that provide the best returns. This is not to say that growth stocks don't deserve a spot in one's diversified portfolio. However, it does mean that investors must be careful to make sure that these faster growing, riskier companies are compensating the increased risk and volatility. As I was researching growth stocks I came across Yelp (NYSE:YELP) and became intrigued by its growth story and decided to analyze whether an investment at the current price made sense. The answer is a definitive "No".
Yelp is a San Francisco based company that has grown into one of the largest local guide service companies in the world. The company's website and apps offer customers reviews of local businesses such as restaurants, dentists, mechanics and boutiques. The company makes money off of local advertising. In addition, through the Yelp App merchants can message potential customers and offer Yelp Deals and coupons which is like Groupon (NASDAQ:GRPN). It allows customers to make reservations at restaurants from the app similar to OpenTable (NASDAQ:OPEN). The company operates internationally with customers in: Australia, Austria, Belgium, Brazil, Canada, the Czech Republic, Denmark, Finland, France, Germany, Ireland, Italy, the Netherlands, New Zealand, Norway, Poland, Portugal, Singapore, Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United States.
Yelp is growing like a weed. By the end of 2013 the company had 120 million unique monthly visitors and over 53 million reviews. The majority of users utilize the website but the mobile App is growing quickly and attracted 10.6 million users thus far.
During the 4th quarter the company reported:
Net revenue of $70.7 million in the fourth quarter of 2013, reflecting 72% growth from the fourth quarter of 2012.
Cumulative reviews grew 47% year over year to approximately 53 million.
Average monthly unique visitors grew 39% year over year to approximately 120 million.
Active local business accounts grew 69% year over year to approximately 67,200.
Net Loss of $2.1 million compared to $5.3 million loss in 2012.
Adjusted EBITDA of $10.4 million compared to $1.8 million in 2012.
Full Year 2013 Results were:
Revenue up 69% to $233 million.
Net loss of $10.1 million compared to $19.1 million in 2012.
Adjusted EBITDA of $29.4 million compared to $4.6 million last year.
The company's guidance for 2014 was:
- Revenues of $353-$358 million, representing growth of 51.5-53.6%.
- Adjusted EBITDA of $54-$58 million, representing growth of 81.2-97.3%.
- Stock option costs of $43-$45 million, representing growth of 59-67%.
Catalysts For Growth:
According to the company's Q4 investor deck presentation there are 74 million businesses in the world. As of 2014 Yelp has 67,200 businesses signed up which represents just 0.09% market share. In addition, total US local ad spending is expected to grow to $145 billion in 2016. Yelp's current $233 million in revenue represents just 0.16% of the potential market.
The strongest potential for growth comes from international users. Yelp reports that international reviews were up 225% in 2013 compared to 2012, while unique visitors were up 101% and revenues increased 256%.
Indeed when one hears figures such as these it is hard not to get excited about Yelp's growth prospects. However, before buying shares investors should be aware of certain risks.
Increasing competition: According to Yelp's Engineering blog, competition is growing from the likes of Google (NASDAQ:GOOG), Facebook (NASDAQ:FB), Angie's List (NASDAQ:ANGI) and TripAdvisor (NASDAQ:TRIP). The moat around Yelp's business is only its first mover advantage. The idea is if Yelp can garner the biggest following early on then customers won't bother trying a competitor's products because the largest amount of data is already available at Yelp.
Quality Control Failures:
A recent study from the Harvard business school found that 16% of Yelp's reviews are falsified. The study analyzed 316,415 reviews of 3,625 restaurants and found that 99% of Boston's restaurants had at least one false review. The false reviews were mostly by owners of competing restaurants and included a combination of praise for one's own restaurant and attacking competitors.
Rampant Share Dilution:
In 2009, Yelp spent $1 million on stock options. In 2014, Yelp is projecting $43-$45 million. This amounts to a 89% CAGR in stock option grants and surpasses the growth rate of sales, users or reviews on the site. In 2014, stock option grants are projected to grow at 59-67% faster than the anticipated growth in sales of 51-54%. Meanwhile the total share count is growing by 12.3% CAGR since mid 2012. This increase in the share count will make it harder to grow earnings, once they appear.
(click to enlarge)
Growth in expenses is keeping up with growth in revenues:
In the last 2 years revenues have soared 216% or 78% CAGR. Meanwhile G&A expenses, the cost of running the business, have soared at 177% or 67% CAGR. Now this is understandable given how fast the company is growing, spending money on advertising, and expanding globally. However, the risk is that those expansion costs continue to grow quickly while the ability to monetize international users proves not as successful. Google and Facebook have found that it takes 2-3 Canadian or European users to be as profitable as one US user. Other parts of the world are even less profitable requiring 5-10 users to match each American. If this finding proves true for international Yelp users then the heavy spending to expand internationally will result in far less of a boost in sales and earnings than previously anticipated.
Massive insider selling:
To the tune of 41% of insider shares in the last 4 months alone. The CEO, Jeremy Stoppleman, has exercised $15.25 million of stock options in the last year and seems to own almost no shares. Instead, Mr. Stoppleman on a weekly basis seems to convert free stock options to the tune of about 15,000 shares and then sell them that day.
The rampant insider selling over the last 4 months began at a stock price of $65.63. This indicates that management (who knows the workings of the company and its long term growth prospects the best) believes that at a price 50% below today's price the stock was blatantly overvalued. As I'm about to show - management is very likely correct.
Projected 5 year price
5 Year Projected CAGR
Projected 10 year price
10 Year Projected CAGR
Projected 15 year price
15 Year Projected CAGR
Projected 20 year price
20 Year Projected CAGR
Projected 25 year price
25 Year Projected CAGR
Projected 30 year price
30 Year Projected CAGR
30 yr EPS CAGR
As seen in this table, I am modeling Yelp's earnings growth out over the next 30 years. I assume the 2016 EPS based on analysts' consensus and then model the expected 43% EPS growth for years 2017-2018. For the next 5 year period I model a slow down to 30% CAGR. Each additional 5 year period models 20%, 15% and 10% growth. In total, my model expects a blistering 21% CAGR in earnings over the next 3 decades. I attempt to apply various multiples to determine the likely price in 2018, 2023, 2028, 2033, 2038 and 2043. Next I discount by the stock market's 1871-2013 CAGR of 9% to find the present fair value. I calculate the discount to that fair value and finally determine the expect 5, 10, 15, 20, 25 and 30 year CAGR that investors can expect from Yelp given its current price. Comparing this anticipated total return to the stock market's historical 9% CAGR (without dividends) and 11.1% CAGR (with dividend reinvestment) can give us an idea if Yelp satisfies the criteria of offering substantially greater reward for its much higher risk. The results are sobering.
Despite a 53% EPS CAGR through 2018 and an estimated 75 PE Yelp is expected to only generate 7.1% CAGR over the next 5 years. The best results are the anticipated 10 year returns of 13% CAGR assuming a PE of 53. From there it just gets worse for Yelp; culminating in a 30 year CAGR of just 8.6% despite a 245 fold increase in earnings over that time. This is purely a result of the sky high current valuation. If the price of Yelp were to drop to $50, a 30% discount from when management began massive insider selling, the results become quite different. The 5 year projected average return becomes 25.2% CAGR and the 10 year return becomes 23.3% CAGR. Sadly the 30 year CAGR only increases to 11.53% which barely beats the stock market's dividend adjusted results. This shows just how overvalued Yelp is. Its truly long term returns simply cannot match the returns of much safer, less volatile dividend stocks.
Examples of such stocks are Brookfield Infrastructure Partners (NYSE:BIP), Prospect Capital (NASDAQ:PSEC) and Main Street Capital (NYSE:MAIN). These high dividend paying companies are far less risky and volatile than Yelp. Yet because of the power of dividends and strong dividend growth these companies are likely to return 14.5-17% CAGR when dividends are reinvested. This is because the total return of these kinds of companies is determined by the yield+dividend growth rate. The yields on Brookfield, Main Street and Prospect Capital are 5.1%, 7.2% and 12.2% respectively. The projected dividend growth rates are 10%, 8.5% and 2.7%. Adjusting for dividend reinvestment nets projected long-term total returns of 15.87%, 14.56% and 16.83% CAGR respectively. Because the nature of growth stocks is higher risk and higher volatility it is important for growth stock investors to look at the projected returns of the companies they own and ask whether they can beat not only the market's 11.1% long term return but the 14-17% that high quality dividend payers can generate. After all, if a growth stock at a reasonable price, can generate 20-25% CAGR over 5-15 years then it is certainly deserves a spot in a diversified portfolio. However, if a stock, such as Yelp, with a massive potential growth runway ahead of it is only likely to return mediocre market matching results then it is not worth risking one's capital on.
So does this mean that Yelp is a stock worth shorting? Absolutely not. Its short interest is 21.4% which indicates a potential for a large short squeeze. The short ratio of 1.6 days indicates that the potential pop would be short lived but any speculators who short Yelp are still risking a margin call that costs them 20-40% of their capital. As the noted economist John Maynard Keynes stated, "The market can remain irrational longer than you can remain solvent."
Yelp is a great service and an innovative company. Its potential for revenue and earnings growth is truly staggering. However, the risks the company is facing coupled with the least shareholder friendly management I have ever seen gives one reason to pass on Yelp as a long-term investment. If management had confidence in the growth of Yelp then certainly the CEO would hold at least some of the free shares the company is handing him ($312,500/week on average). Such brazen acts of shareholder dilution serve a valuable purpose that they tell us that Yelp is worth far less than $65/share which is the price at which management began its epic share dump. Perhaps one can make money shorting the stock or speculating with options but that is the realm of the gambler not the investor. For market crushing long-term returns investors would be best served to look elsewhere.