- Just because a stock fell sharply recently does not mean it is cheap.
- Yelp's business model of spending $50 million in marketing to generate $45 million in revenues is not sustainable.
- Even if all analyst goals are met, we are still looking at a ridiculous forward valuation.
- Revenue-wise the growth opportunities are limited for Yelp outside of the US.
Yelp (NYSE:YELP) is one of those companies that enjoy a ridiculous valuation even as many of the high-flyers in the market are going through corrections. While between the beginning of the year and now Yelp's price fell from almost $100 to nearly $50, the company is still ridiculously overvalued and even the most bullish projections don't justify the current price. This tells us that just because some stock fell by 50% doesn't mean it is undervalued.
After growing its revenues by an annual average of 70% for the last three fiscal years, the analysts expect the company to grow its revenues by 57% this year, 41% next year and about 40% for the next three years. While these are very bullish projections, even these projections don't justify the current share price. Even if Yelp meets these ridiculously high projections, it will still have revenue of $1.39 billion by 2019 and this gives it a forward price-to-sales ratio of 3. Of course, we have to discount for the appreciation we expect in share price in addition to the ongoing dilution. If we discount 15% for share appreciations (which is fair because this is a high-beta stock and when people invest their money in a high-beta stock, they expect high volatility and higher-than-average returns for taking a risk) and 5% for the dilution we actually find out that Yelp's forward price-to-sales ratio is actually 9 even if it meets all the analyst goals.
Also, keep in mind that Yelp's business model of "spending $50 million on sales and marketing in order to generate $45 million in new revenues" is not sustainable and will not result in profitability anytime soon. Even if the company meets all the analyst estimates for future revenues, it is still highly unlikely to become profitable since this is something Yelp has never achieved in its history. Every year, the company's revenue grows tremendously but the company's expenses grow just as rapidly (if not even at a faster rate), resulting in no profits.
For example, four quarters ago, Yelp generated $55.02 million in revenues and booked $55.60 in operating expenses. In the following quarter, the company grew its revenues to $61.18 while the operating expenses grew to $62.96. The quarter after this one, Yelp's revenues grew to $70.65 million while the operating expenses rose to $72.56 million. In the last quarter, Yelp's revenues grew to $76.41 million while operating expenses rose to $81.01 million. The company's guidance for the full-year also calls for operating expenses rising as fast as revenues and we are looking for another year with no profits.
The analysts are still very generous to this company as they expect it to report a profit in 2015. The analysts expect Yelp to generate a profit of 32 cents per share by the end of 2015. Keep in mind that there were several other instances when the analysts thought that Yelp was going to post a profit and they were wrong every single time.
Even if we agree with the analyst estimates, we are looking for 32 cents per share in net earnings by the end of 2015 and a 40% growth for the next 3 years, after which, the growth will slow to about 20%. So, we are looking at profits of 45 cents per share in 2016, 63 cents per share in 2017, 88 cents per share in 2018, $1.05 per share in 2019 and $1.26 per share in 2020. Assuming no dilution and no share appreciation, we are still looking at a forward P/E of 47 by the year of 2020 even in the bullish scenarios of the analysts! If we assume a 15% discount and 5% dilution since the company continues to increase its diluted share count every quarter at a steady rate in order to pay its management generously, we are looking at a forward P/E of 138 even as late as 2020. This is as ridiculous as it gets. No growth company in the world is given a 100+ P/E that might or might not happen 6 years down the road.
If the company were given a P/E of 20 by 2020 and it met all analyst targets, its current price would be about $9 per share as opposed to the current price of $60 (when we consider the discount factor for dilution and future price appreciations). In order for Yelp to deserve the current share price, it would have to earn $8.73 per share by 2020, which is far, far above the analyst estimates.
Where will this growth even come from? Yelp is already established in all major cities in the US and the company won't get much business in small or medium-sized towns. After all, why would someone who lives in a small town look for a local restaurant online? There is really no big city in the US where Yelp is not already established and well-known. Apart from the US, the company can chase growth in Asia and Europe; however, it won't profit much from those growth figures. According to the company's latest quarterly report, each American viewer of the website or the app results in 11 times as much revenue as an international viewer. In other words, Yelp wants to double its revenues by expanding international markets, it will have to find 11 viewers for each American viewer to generate the same kind of money. If Yelp couldn't even make a profit in the American market, how will it make a profit in markets where advertisement revenue is a fraction of what it is in the US?
Every time I hear bulls on Yelp talk about how cheap the company is, they always say "Yelp has so much potential, it could be the next Google" but we see absolutely no sign or evidence of this ever happening. Just because some people say it has a lot of potential doesn't make it so. Even the management of the company doesn't want to hold any shares and many shares are dumped in the market as soon as they are awarded to the executives. A lot of people also argue that Yelp will get acquired by Google or Yahoo but if the company had any hopes of getting acquired anytime soon, the management wouldn't be dumping shares to the market as if they are hot potatoes, right?
No matter how you cut it or how you look at it, there is no way to justify Yelp's current valuation. Spending $50 million per quarter on sales and marketing to generate $45 million in revenues is not a sustainable business model in the long term; neither is selling overvalued shares in the market to raise cash every year. The analysts currently have a price target of $83 on Yelp but even they don't know how they came up with such valuation. Yelp is not much more than a typical pump-dump stock and we've seen a lot of these during the dot.com bubble of late 1990s.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.