Yelp (YELP), the "local" online review site, recently announced that it would be reporting earnings on November 1, 2012. The company's share price saw significant upward action in September after its initial lockup expiration period ended. The upward price movement continued through October due to Yelp's integration into Apple's new operating software map feature. There is no question that Yelp's local sales teams should have been able to benefit from the hype generated by sales of Apple's (AAPL) iPhone 5. Profitability for Yelp this past quarter should be a foregone conclusion. The more important questions are how Yelp is going to deal with Apple's massive map failure, whether it can successfully monetize mobile, and how it is going to deal with poor crowd-sourced data and fake reviews, along with whether it can survive in an increasingly crowded business segment.
Local Online Review Business Segment About To Get A Lot More Crowded
Yelp is likely to be one of the beneficiaries of Google's (GOOG) recent earnings miss. Although Yelp has never been profitable (and even Zynga was profitable at one point in time), the revenue that Google lost this past quarter had to have gone somewhere. Despite the strong likelihood of profitability, Yelp's investors nevertheless need to be concerned. Investors need to ask whether Yelp has the ability to continue generating more quarters like the one it will report on November 1, in light of the fact that the "local" online review business space is about to get a lot more crowded next quarter. Within the past few weeks, there have been rumors and/or announcements of many more companies that will be entering into the business space that Yelp currently occupies. Three such companies possibly looking to take advertising dollars from Yelp are Facebook (FB), FourSquare, and Restaurant.com.
This highlights one of the most important flaws (one of many) in Yelp's existing business model. The company has no moats. Any company with an online presence, an IT department, and local sales force (although arguably both the IT and sales force functions could be contracted out) can do exactly what Yelp does. So long as Wall Street thinks that Yelp should be valued at over $1.5 billion, there is nothing that prevents other companies like Amazon (AMZN), Groupon (GRPN), and LivingSocial (each with a strong online presence and brand, relationships with businesses in local markets, and a local sales presence devoted to generating local revenue) from making the decision to try to take some of those investment dollars that are funding Yelp's current lofty valuations.
Most importantly, if Yelp wasn't able to turn a profit during the time when the business space it occupies was relatively empty (with the possible exception of this past quarter), why should investors expect it to become consistently profitable as more companies start joining the party?
Apple Maps = FAIL
After Yelp's last quarterly earning call, the company's stock price jumped because of significant increases in overall existing and forecasted revenue projected from Yelp's integration into Apple's Maps. This integration likely helped convince local business owners to pay their pound of flesh to Yelp with the expectation that millions of future iPhone 5 purchasers would be using Apple maps. While Yelp's integration into the Apple map feature was generally considered a success, the overall map feature has been universally denounced as a failure. Even Apple CEO Tim Cook recommended that iPhone users turn to other mapping applications until the bugs in the Apple program could be worked out. To add insult to injury, it turns out that part of the problem with Apple's Maps program was that it was relying on outdated or "dirty" information being pulled from Yelp.
The whole situation turned into a massive nightmare for Apple. Logically, if Cook told his customers to use an alternative mapping application, local businesses no longer have the same incentives next quarter to advertise with Yelp. Yelp's sales teams won't be able to rely so heavily on the Apple map marketing pitch, now that small business owners realize what a failure the Apple maps are. Additionally, taking the logic one step further, if Yelp's "dirty" data was part of the reason why Apple's Map application was such a large failure, the next question is whether Yelp integration will remain a prevalent feature in the Apple map application (assuming, of course, that Apple intends to truly fix its problems).
Yelp - "Dirty" In More Ways Than One
While the Apple map fiasco exposed the fact that Yelp's data on business locations and addresses can often times be "dirty," this is not the only thing dirty at Yelp (and no, I'm not talking about the dirty sales tactics employed by the company where sales people offered to remove bad reviews for business owners in return for a hefty monthly fee). The company's recent push to shame businesses to refrain from purchasing reviews exposes another serious flaw with Yelp's business model. Simply put, some reviews on the company's site are faked, and there is no way to control for this problem (except to shame businesses out of doing it). Sure, shaming companies who pay money for their reviews is one possible way to try to fix this problem, but what happens when companies offer patrons a discount in exchange for posting favorable reviews? Will that type of action trigger Yelp's "badge of shame" as well? Of course, that also begs the question, what happens if a company starts submitting lots of reviews for their competitors from one IP location, or if a company posts a fake Craigslist ad trying to buy fake reviews in the name of a competitor's business? What due process, if any, will innocent companies be given?
This is where Yelp's upcoming competition has a leg up on the company. Who better than to trust than your friends? Facebook's decision to enter into the local online review business will likely mean that users will be able to filter reviews of businesses based on reviews posted by friends. FourSquare reviews will likely be limited to those individuals who have previously "checked into" an establishment. Restaurant.com reviews are limited to those foodies that have actually purchased and used a restaurant.com gift certificate. Amazon, Groupon, and Living Social reviews could each also be limited in the same way (i.e., limited only to those who have actually purchased and used one of their promotional offers).
Unless Yelp changes its existing business model to filter out fake reviews without punishing potential customers (i.e., the small businesses who pay the site for advertising), the upcoming competition will be poised to eat Yelp for lunch.
Inability To Monetize Mobile
During last quarter's earnings call, Yelp clearly indicated that it had not been able to monetize mobile revenue. Specifically, the company indicated that "we're looking at sometime soon for mobile app monetization, we haven't announced an actual date, but it's obviously a high priority and something that we'll be doing soon." Despite the "high priority" Yelp's management purportedly put on mobile monetization, Yelp has failed to provide investors with any announcements of how it will be achieving this goal. Rather, the company seems to be more focused on breaking into international markets like Poland and Singapore.
While it's certainly much more fun (and more expensive) for Yelp's management team to throw lavish "Yelp Elite" launch parties overseas while hanging out with pretty young Eastern European and Asian "twenty somethings," the company's focus at this stage should be on exploiting local U.S. markets, where it is an established brand, and on monetizing mobile revenue in the face of very stiff upcoming competition that already has a very strong mobile presence domestically (e.g., FourSquare and Facebook).
Yelp better be able to give a good answer (emphasis on good) as to how it intends to monetize mobile revenue on its upcoming earnings call, otherwise, investors might start really wondering why co-founder and CEO Jeremy Stoppleman disposed of so much of his stake in the company during the months of September and October.
If Yelp can't address the problems identified above, in addition to the many other problems identified elsewhere in other articles, then the only value it has is as a content acquisition target for another company. If that's the case, then the only question investors should be asking is whether Yelp's poorly crowd-sourced database and fake reviews are really worth approximately $1.5 billion.
As Jeremy Stoppleman sold off more than $15 million worth of his stake in the company over the past two months, Yelp's own CEO doesn't seem to think so. Why should you?
Additional disclosure: Nothing in this article should be construed as legal or financial advice. The opinions expressed in the article are the author's own. I have a negative outlook on Yelp and am long Yelp put contracts, meaning I have a negative outlook on the company.