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Summary

Yelp (NYSE:YELP) is schedule to price this week with the proposed range from $12 to $14. It's a quality player in aggregating user-generated content around local businesses. Their content and services drives advertising demand from businesses who are faced with the need to tap into more online avenues for visibility and to try and manage their brands and acquire customers.

Yelp has executed well but their model relies on a high cost sales and marketing approach that depresses operating margins. Our IV estimate suggests a $13 to $15 per share valuation which leaves little upside and much risk.

Positives

  • Strong growth in monthly unique users, reviews and covered business locations. Revenue visibility is good.
  • Increasing use of mobile devices tends to increase demand for localized content.
  • In general Yelp has clearly superior local content in terms of number of reviews, depth of engagement and breadth of local businesses covered.
  • Gross margins are very high as they should be in a digital business so if operating effectiveness can improve they company will eventually show increasing returns to scale.
  • Overall we give the management team pretty good marks for market vision, leadership and execution.

Neutrals

  • Another dual class of stock concentrates power with management. These arrangements cut both ways in that they encourage longer-term planning but can also become an obstacle to dealing with poor managers.
  • Yelp is differentiated in the market but it's not clear if this segment is substantive enough to be a separate public company.
  • There remains some debate around the credibility of online reviews in general and with Yelp in particular. True user-generated content has proven to be much trickier than many expected and Yelp depends on this content more than most companies.
  • Our base case IV comes out with a $16 per share value, which compares to the $13 mid-point. However this relies on massive margin improvements in later years.

Negatives

  • Growth has come at a high cost operating expenses have grown at a rapid clip with high expenses for sales and marketing and G&A. Specifically, these expenses increased $26M to drive an incremental $35M in revenue in 2011.
  • Sales and marketing is run like a machine, which churns a large number of recruits through the system. Yelp is a value proposition that is sold rather than bought and it's not yet clear if this will change.
  • Yelp is still a relatively small player in a large market with intense competition. In addition to large players like Google (NASDAQ:GOOG), there are other niche players in restaurants (NASDAQ:OPEN), services (NASDAQ:ANGI), retail (NASDAQ:GRPN) and many in hotels and travel.
  • International markets have been problematic for similar businesses and it will take time to know to what extent the Yelp approach will work in markets outside of US urban areas.
  • Consistent with our IV comment above, there is not much current period share price support until 2015 even if the company hits their operating targets. More reasonable long-term financial model targets yield an IV of $13.50, which provides little upside from the proposed offering range.

Conclusion

Yelp will be joining a parade of recent money-losing internet companies in testing the public markets. Given the IV and filing range, there's not much to get excited about in terms of the IPO.

Source: Yelp: Not Much To Get Excited About