Similar to pets.com, Yelp (NYSE:YELP) is a dog of a stock. Certainly, Web 2.0 and pets.com reincarnated supporters will bark, wail, yelp, beg, scratch, and claw for this stock to remain relevant, right before things hit the fan, shares collapse, and Yelp positions go out with a whimper. Yet again, we are forced to deconstruct the economic merit of another novel Internet idea that went public and cashed out for $1 billion at the top. Accommodative Federal Reserve Board policies, alongside unrealistic business expectations, serve as catalysts to lead us on this death march toward zero.
The Federal Reserve Board
The Federal Reserve Board is an apolitical entity that functions to achieve a contradictory dual mandate of full employment and stable price levels. The Federal Reserve works to influence the economy largely through its overnight lending rate. Member banks borrow money from each other at the overnight lending rate to meet their reserve requirements at the Fed. Logically, the overnight lending rate serves as a benchmark for all credit securities. Creditors demand higher returns on their investments relative to the minimal risks that banks incur when loaning reserves out to each other. Amid a recession, the Fed will drive rates lower in hopes that people will take out loans, purchase big-ticket items, and put money to work within financial markets to stimulate the economy.
At present, the federal funds rate is zero. The federal funds rate has remained at zero since Q4 2008, in response to a parade of boom-and-bust economies that began with the dot-com bust and ultimately transitioned into a credit debacle. With interest rates significantly beneath inflation, investors have embraced risk in hopes of generating real returns. These are the makings of a bubble.
Right now, I feel that Yelp and the entire Web 2.0 complex is yet another example of cheap money fluff that is doomed to fail.
Yelp Share Price
On March 2, 2012, Yelp made its public debut to much fanfare. Initially priced at $15, Yelp shares rocketed up on their first day of trading to close at $24.58. On the surface, the 60% opening day surge had the markings of a successful IPO. I would argue, however, that lead bankers at Goldman Sachs underpriced demand for the offering, collected their fees, and left money on the table that Yelp could have used to finance operations. In the two short months following its IPO, Yelp approached $32 per share, before settling in at $22 on April 23, 2012. Today, Yelp posts a $1.2 billion market capitalization.
Yelp's S-1 filing, however, indicates that this corporation never turned a profit between 2006 and 2011. Losses have actually been mounting, as Yelp builds out its sales staff for increased visibility and market penetration. Although revenue has taken an elevator ride from $443,000 in 2006 to $47 million in 2010, costs and expenses from operations also levitated from $2.7 million to $57.2 million during this time frame. In total, Yelp closed out 2010 with $9.7 million in net losses. Even happy-go-lucky speculators who highlight cash flow figures must note that Yelp's cash flow from operations has fluctuated wildly over the past three years, from negative $633,000 to negative $7.8 million to a positive $250,000 between 2009 and 2011. By year-end 2011, Yelp had gone on to lose $5.3 million from its 2010 cash position.
I cannot justify paying a $1.2 billion valuation for any stock that posts significant losses and continues to burn through cash. At these levels, Yelp investors must be willing to make the argument that either online advertising is set to capture the lion's share of traditional print dollars, or that this company is a prime takeover target for established Internet players.
Yelp's Flawed Business Model
Yelp is a website and smartphone application that facilitates a marketplace for consumers, advertisers, and small businesses to exchange information. Central to Yelp's model are consumer reviews that registered users can post to describe their experiences at local businesses. From there, Yelp can market advertising packages to local businesses alongside links and banner ads for multinational corporations.
Yelp, as a crossroads for Internet traffic, is quickly degenerating into a train wreck. Irate small business owners have taken to various message boards to go on the attack and slam Yelp as an "extortion scheme." Unwitting merchants believe that Yelp brass purposefully allows negative commentary to pass muster on the site, while filtering out positive feedback. In order to reverse this dynamic, local businesses report that they feel compelled to purchase expensive advertising packages on Yelp. According to technology consultant Rocky Agrawal, Yelp is selling advertising space to small businesses at $600 per 1,000 impressions, which is 1,000 times higher than the going $0.60 rate. I feel that only financial conglomerates that close six-figure deals should pay a premium for online advertising. Alternatively, mom-and-pop restaurants that offer spaghetti at $15 a plate are better left alone.
Yelp supporters, of course, will battle back and claim that local merchants should literally mind their own business and excel at customer service to avoid bad reviews and get their dollar's worth. I would argue, however, that the integrity of Yelp's review system and its advertising price points are myopic concerns, at best. Right now, Google (NASDAQ:GOOG) and its search engine machine is responsible for roughly half of all Yelp traffic. At any moment, Google could re-engineer its own search algorithms to direct consumers toward its upgraded in-house suite of quasi-review sites, such as Google+ or Google Maps, and steal share. Google, of course, would only aggressively enter this arena at the exact moment that Yelp was to flash any signs of life.
Yelp will be finished if Google ever decides that it wants to come out and play.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.