Shorting Yelp (NYSE:YELP) boils down to shorting an over-valued "social media" type company that makes no money and is experiencing slowing growth metrics across the board. The internet review space is a crowded field, and investors are expecting best case scenarios for a company like Yelp in terms of future ad monetization rates.
I do think Yelp provides a valuable service (I use it all the time), however the market is rewarding Yelp shareholders before the company has even proven it's worthy enough to warrant an 11x forward revenue multiple. My guess is that this stock has a big leg down coming at some point over the next couple of quarters when the Street sees that the company's revenue metrics continue to degrade.
You most likely know Yelp as one of the most well-known review sites on the internet currently. Yelp generates over 90% of its revenue from pure advertising. About 70% of revenue is comprised of local ads - to be clear, local businesses (like restaurants or various shopping stores) do not have to pay to be reviewed on Yelp. They simply pay to have their restaurant name appear on the side of the website, or to be more prominently displayed on the website. Then about 20% of revenue is comprised of brand advertising, which are for bigger company accounts with more of a national presence. The remaining <10% of revenue comes from a variety of other services like Yelp deals and such.
As you probably expected, restaurants are the most common businesses that are reviewed on Yelp. Penetration of the local market is the key to Yelp's success. The company claims to have 30.3 million reviews on the Yelp site with about 78 million unique visitors each month. Yelp is in 90 markets around the world, 51 in the U.S. and 39 in international markets. The company does have a Yelp app, but it does not generate any ad dollars from the app. Just like most social media companies, figuring out how to monetize the smartphone is key to the company's success.
Main points to the short:
1. Small markets to penetrate: Yelp has been opening up in major cities in the U.S. since 2004 (when it was founded), and started going after international markets in 2009. It experienced exponential growth as these major markets were tapped, and the company was able to rake in remarkable top line growth, as these were all big cities with tons of restaurants and tons of local ad dollars being spent on Yelp. Yelp then tapped major European cities and also English-speaking international cities, which were easier to tap and quicker to build a presence. Yelp continued to grow its cumulative market penetration, but what it saw in 2010 and 2011 was a serious slowing in monetization rate growth. As Yelp has tapped all of the big, English-speaking markets early on in its life, it was able to monetize those markets pretty effectively. Yelp saw a sequential decline in revenue per market for the first time in the 1st quarter of this year, as the markets it is now entering are not as lucrative as previous new markets. Revenue metrics have plateaued somewhat in the $1.5 million per market range. I do not see how this metric can move up significantly.
2. Smartphone monetization: Yelp currently generates zero revenue through its Yelp app. It generates a very small amount of revenue via ads on mobile devices for users who simply use the regular Yelp.com website on their smartphones. So the question is: will Yelp figure out how to make money off of the smartphone, and how fast will this monetization occur? This is the question that's plaguing basically every social media company right now. You're starting to see some testing ad methods from the likes of Twitter (ads amongst your twitter feeds) and other companies, but nothing really substantial yet. However, when talking with Yelp's 3rd party investor relations department, it did not seem like mobile monetization had real urgency.
3. Reviews are competitive: Restaurant and travel reviews are definitely helpful when choosing locations, I admit. And that is why big players are continuing to grow presence in the online review space. Google (NASDAQ:GOOG) acquired Zagat at the end of 2011 in an effort to help build up Google Places and Google+ Local. Google also acquired ITA software in 2010 as it was building a presence in the travel space (and travel review) space (I point this out as an example to demonstrate that Google is actively going after this review space). This competitive threat would not be out of the ordinary except for 2 things: (1) This is Google we're talking about and money is not an issue if it wants to enter an industry, and more importantly (2) about half of Yelp's online traffic comes through Google.com.
- Aggressive valuation: Yelp is trading at 11x forward revenue, and it generates negative EBITDA. So the market is implying that Yelp's market is 11x bigger than today, and that the company will be able to penetrate these markets without fail. Another way to quantify what the market is assuming for Yelp is to make aggressive forecasts of the business model and checking out what that spits out from a DCF perspective. In order for the company to be valued in the mid $20/share price range, you'll have to assume that Yelp grows its revenue per market metric 10% for the next 5 years, which is extremely tough to do given the past couple quarters of monetization growth. Also I'm assuming they open over 23 new markets a year (on avg), most of which is front-loaded assuming 36 this year (annualizing the current 6 months of this year), even though Yelp peaked in 2010 + 2011 at 22 new markets per year. Can they really keep this up?
More detailed analysis with valuation and financials can be found here.