Much ado was made when the Yelp (NYSE:YELP) stock lockout date (08/28/12) came and went without major insider selling. The "insider discipline" was celebrated, Yelp was crowned the anti-Facebook (NASDAQ:FB) in terms of post IPO performance, and the share price has since risen by 40.7%. However, Yelp is significantly overvalued at its current 1.57 billion dollar market capitalization. Yelp is a prime short candidate because much of the perceived post lockup confidence is contrived, the tremendous recent growth was driven by fallaciously impatient short covers, the stock's fundamentals are poor, and the company's business model is flawed.
To its credit, Yelp has perceptive management who understand the importance of conveying confidence immediately after the lockup expiration, especially in light of the recent negative performance of Facebook, Zynga (ZNGA), and Groupon (GRPN). They knew that if they exited en masse at the lockup expiration then it would undermine investor confidence. Instead they held onto their shares at the expiration date and enjoyed the resulting positive press.
However, starting a week after the lockup expiration and up until September 14, 2012, the COO, CFO, and CEO have all sold stock of varying quantities and significance. CFO Robert Krolick sold 1,000 shares on September the 4. Six days later on September 12, COO Geoffrey Donaker sold 35,000 shares. Most significantly, on September 14, CEO and co-founder Jeremy Stoppelman sold 590,790 shares. No officer has increased their position in the company since the lockup expiration. The management team both generated a share price pop from perceived insider confidence, and exited at higher prices away from the media spotlight of the lockup expiration weekend.
Besides the effect of people covering their shorts after seeing no lockup day crash, there have been many other reported reasons for the rapid increase in share price over the past three weeks. People point to the fact that Yelp will be integrated in the new iOS6, that it is a likely buyout candidate, that it is expanding to Asia, and that it is well positioned for mobile. None of these purported advantages are substantial enough drivers of value to justify the current valuation.
IOS6 integration should increase traffic and brand recognition, but without a clear path to monetization, these increases are not very valuable. It is very unlikely that Apple (NASDAQ:AAPL) is willing to leave a lot of profit on the table for Yelp in whichever capacity it cooperates on Maps or Siri integration. There have been no substantial buyout indications beyond speculation that it would be an "acquisition target" for a company like Google (NASDAQ:GOOG). Asia does offer tremendous growth potential, but as can be seen from the failures of Facebook and Google in that area, there are often preferred alternatives already established in the Asian space. Being well positioned for mobile is an advantage it has, as their apps are effective across all mobile platforms. However, it is having the same difficulties as Facebook in determining how to monetize mobile page impressions, and in its case restaurant and business recommendations. Just because its service is more optimized for mobile than Facebook or Zynga does not mean that it is any more advanced at figuring out how to monetize mobile.
As far as the stock's fundamentals, there are many areas of concern. The company has never been profitable, something that Zynga and Facebook were before their IPO. Its Price to Sales (14.95) and Price to Book (11.39) are much higher than the industry averages of .92 and 1.49. It is forgivable for a company in the growth stage of its maturation to have poor figures here, but the profitability and revenue numbers are cause for the greatest concern.
Even if the company continues with the 67% YOY increase in revenue that it reported in the second quarter of 2012, and finds a way to boost net income from negative to margins into the 5 -15% range, it will be years before the company offers returns consistent with its current market capitalization. With optimistic analysts putting the earnings per share in 2013 at anywhere between $.05 and $.08 it seems unlikely that Yelp will achieve significant profitability anytime in the near future.
Further causes for concern about Yelp's future profitability are the flaws in its business model. The company suffers from the same problem that other major Internet companies do in that they offer their service for free. Yelp has indicated that they are monetizing by running advertisements and by getting merchants to pay for benefits in the reviews display. The problem with this is that its mobile app is currently not profitable and they face the same problems that Facebook does in monetizing the app space with miniature banner ads. Some say that Yelp is better positioned for ad revenue because people visit the site with the intention of spending money on something. However, Yelp is not capitalizing on this advantage because only 4% of the merchants are paying for any services according to the New York Times.
Additionally, Yelp faces the problem that merchants with bad reviews are not inclined to pay Yelp for anything because they resent them. Merchants with good reviews also do not feel the need to pay Yelp because they already receive an increase in traffic as free riders on the service. To make matters worse, many merchants are disenchanted with Yelp because they think that they either hide positive rankings until payment is procured, do too little to eradicate low rating trolls, or generally use predatory tactics to try and bring additional customers on board. A company so at odds with its customers is not one that is poised to experience the multi-year growth that Yelp needs to see in order to live up to its current market capitalization.
Short Yelp because of the façade of insider confidence, artificial short term stock price rise caused by covering shorts, unachievable growth requirements, and flawed business model.