Local business guide and review site Yelp (NYSE:YELP) had a wildly successful 7.2M share initial public offering ("IPO") that saw shares surge 64% in one day as investors clamored to gain exposure to one of the larger Web 2.0 companies. Fast forward 180 days and now 52.7M additional insiders shares are available for public sale as the lockup restrictions expire. Insiders are commonly restricted from selling their shares immediately following an IPO to dampen volatility in the underlying stock. Conventional wisdom dictates that Yelp would sink like a stone with such an influx of shares available. Basic economic theory dictates that if the supply increases without an increase in demand, the market price must fall. So that's what happened, right? Not quite.
Yelp enjoyed its greatest single day rally since the IPO with the stock jumping 22%. In contrast rival social networks Facebook (NASDAQ:FB) and Zynga (NASDAQ:ZNGA) are getting hammered as early investors continue to shed their shares as fast as possible. Investors may wonder why these two similar companies acted so differently when their lockups expired. There are three reasons that separate the Yelp from Facebook and this can teach an important lesson to investors who find themselves in similar situations going forward.
1. Insider Discipline: Yelp's insiders exercised restraint and did not dump their shares en mass. "It's refreshing to see insiders with discipline," said Michael Pachter, a Wedbush Securities analyst. Mr. Pachter is spot-on as Yelp's insiders generally did not sell in the IPO and opted to express their confidence in the company. If insiders sell significant stakes at the initial offering it is a good sign that they will sell more in the future. In fairness to the insiders the Facebook offering was much larger so insiders had more pressure to sell for diversification purposes.
2. IPO Size: Yelp's IPO was a much smaller than Facebook's IPO as Facebook dramatically increased the number of shares being offered mere days ahead of the IPO. By offering a limited number of shares Yelp was able to effectively make it very expensive to short the stock. It was virtually impossible for Facebook's short interest to match Yelp's short interest because Facebook was almost 100X larger at its IPO (that gap has now narrowed to approximately 25X).
3. Short Squeeze: The third reason is a culmination of the first two. Confident insiders plus nervous short sellers equals a short squeeze. When the anticipated selloff did not materialize the shorts were forced to scramble and cover. This added more fuel to Yelp's increase. Facebook did not have a short squeeze because investors dumped their holdings and the shorts actually made money.
Having said all this, I still have mixed opinions on Yelp. On one hand local advertising is extremely expensive which explains why the company's revenues and costs have been rising at the same rate. On the other hand Yelp is poised to experience accelerated growth as it could benefit from the Apple (NASDAQ:AAPL) effect. In Apple's newest mobile operating system, iOS 6, Yelp will be featured prominently in the Siri personal assistant. I continue to rate Yelp as a HOLD in this challenging environment for local businesses but the Apple halo could push shares higher in the next six months.
Additional disclosure: Author is short AAPL Aug 31 $690 Calls.