Yelp - Bubbles Swell Before They Burst

| About: Yelp (YELP)

On the morning of October 24, 2012, Yelp (NYSE:YELP) issued a pre-earnings announcement indicating that it was acquiring rival European competitor, Qype. The company also announced that revenue for the third quarter would likely be higher than many analysts predicted, but that it would still be unprofitable. Shares of Yelp swelled through mid-day trading on October 24, 2012 to close seven percent higher than the day before.

While Yelp's announcement of better than expected revenue was well timed to take advantage of Facebook (NASDAQ:FB) and Yahoo's favorable earnings calls, the information provided by all three companies earlier this week should leave Yelp investors very concerned. Based on the information released by the three companies, it is now clear that:

1. Yelp is not likely to be acquired,

2. Its ability to survive as a standalone business is highly questionable,

3. The company's organic growth has stalled and its future growth strategy is dubious at best.

Girl Next Door Pretty; Princess Attitude:

During Yahoo's (NASDAQ:YHOO) earnings call, the company's CEO Marissa Mayer quickly quashed any speculation regarding whether Yelp might be an acquisition target at its current valuations. As described here, the guidance she outlined for future acquisitions shows that her focus moving forward will be to acquire small companies for technology and talent, not content. During Facebook's last earnings call, Mark Zuckerberg, outlined a similar strategy to acquire talent (as described here).

The announcements issued by Yahoo and Facebook are important because it shows a shift in what top tech and internet companies are placing value in. It appears that the industry as a whole learned from Apple's (NASDAQ:AAPL) map fiasco, and has decided to place a much higher priority on good technology and talent that will draw crowds to their websites, rather than on crowd sourced content (which helped cause Apple's map problems as described here).

Sure, there was once a time when Google (NASDAQ:GOOG) and Yahoo were each interested in Yelp as a potential acquisition, but Yelp previously rejected both of them as suitors. Today's landscape is much different now that Google has Zagat, Yahoo seems to be pursuing Open Table, and Facebook appears to have decided to muscle its way into the picture (as described here).

So it stands to reason, with very little hope for being acquired at current valuations, can Yelp survive an increasingly competitive landscape as a standalone company?

Four Straight Quarters of Unprofitability:

In addition to announcing the acquisition of Qype, Yelp's pre-earnings announcement also made it clear that it would, yet again, be unprofitable. After the tech bubble burst, one would've thought that financial disasters like Pets.com would've taught investors to more closely question a business model that has failed to make a profit since its inception.

To be fair though, all good companies have bad quarters. More importantly, start-up tech companies often need to spend significant cash to generate substantial growth, which comes at a cost. Unprofitability in and of itself is not always a red flag. For example, Facebook announced an unprofitable quarter, but the significant increase in revenue offset any concerns raised there. Yelp investors who bought on October 24, 2012 stand to reason that the "revenue-beat" generated by the company should also be viewed in a favorable light as well. Of course when the onion is peeled back, there are significant differences between the two companies and their situations. Unlike Facebook, Yelp has never seen a profitable quarter. Unlike Facebook, most investors expected Yelp to be profitable in a quarter that was hyped to be a blockbuster due to Yelp's integration into Apple's iOS 6. The potential for profitability was probably the reason that initial investors held onto their shares after the lockup expiration, and the reason why Yelp stock soared in September and early October.

Sadly, Yelp's pre-earnings announcement of slightly better than expected revenue and a smaller than expected loss leaves much to be desired. If Yelp was unable to be profitable in an overhyped quarter, right before it was integrated into Apple's maps, what hope does the company have of ever being profitable now that Apple's maps have been derided as a complete bust? In the one quarter when Yelp was best positioned to prove that it could function as a standalone company (rather than as a bit player with aspirations of being acquired by another), it simply failed to deliver.

How will Yelp compete as a standalone company in a business space becoming increasingly crowded by the likes of tech titans such as Google/Zagat, Yahoo/Open Table, and Facebook? What does Yelp have in its hip pocket to protect its position from other mid-size players like Urban Spoon, Angie's List (NASDAQ:ANGI), and TripAdvisor (NASDAQ:TRIP)? What moats will Yelp rely on to prevent companies like Amazon (NASDAQ:AMZN)/Living Social, Groupon (NASDAQ:GRPN), or any other Tom, Dick and Harry with a website, from entering the competitive landscape? It's clear that cash or profits are not on the list of answers to those questions.

Based on the latest press releases issued by Yelp, the company's path forward is clear. It is banking on survival by growth outside the US through expansion and acquisition.

Yelp's acquisition of Qype = MySpace acquiring Friendster:

While planning international Yelp Elite parties in Poland and Singapore are probably time consuming and intensive, someone at the company should probably alert Yelp's management team to the fact that there is a current global economic crisis facing the world. Alan Mulally, the CEO of Ford, seems to understand this as his company mulls the decision of whether to close plants in Europe. Marissa Mayer also seems to understand this as she extricates Yahoo from various overseas positions (as described here and here) and when she indicated that: "We'll stay in markets where we can find growth and exit where we can't." In fact many top companies recognize how difficult markets are in Europe and Asia, which is why they are trying to re-focus on their energies elsewhere. It is entirely unclear exactly why Yelp believes that overseas expansion and acquisitions are a good strategic business move in today's global economic environment.

Even more confounding though is Yelp's decision to acquire Qype. While Qype offers Yelp more content by bringing accounts and reviews of more overseas businesses, there is little value to the acquisition beyond that content. The move is strategically no different than if in the early 2000's MySpace announced that it would be acquiring Friendster in an attempt to acquire more accounts and content to compete with Facebook. More importantly, the move is in the opposite direction currently being taken by other internet companies like Yahoo and Facebook. As discussed above, both Facebook and Yahoo understand that in today's market, companies need to be acquiring technology and talent rather than content (since content will come when a company has the right technology and talent). It appears that since Yelp is unable to compete with the other companies for the technology and talent necessary to be successful, it has been relegated to settle for content acquisitions in an attempt to convince investors that it has a viable future as a standalone company.

Conclusion:

The stock price spike generated by Yelp's pre-earnings announcement on October 24, 2012 completely evaporated after many investors had time to digest the information generated by the earnings reports of Yahoo, Facebook, along with the pre-earnings announcement from Yelp.

Some investors may decide to hold onto their position in Yelp until November 1, 2012 to hear what the company's management has to say on its quarterly earnings call. They may be clinging to the hope that the future of Yelp, after four straight quarters of unprofitability, will hinge on information to be provided during that call. Those investors should be wary though, because not only must those answers be good, they must be believable. Of course some Yelp shareholders, like Jeremy Stoppleman (Yelp's CEO), and Geoffrey Donaker (Yelp's COO), seem to have realized that bubbles swell before they burst and have timed (as seen here and here) their exit points appropriately.

And of course for all of the rest of those looking to make money off of Yelp, it appears that the company is willing to pay millions to acquire other online review sites. Those with the right kind of gumption to start their own business might find this as an attractive alternative. Remember though, for those who choose to go this route, when closing the deal with Yelp, make sure the sale is consummated with all cash and no stock.

Disclosure: I am short YELP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long Yelp puts without any position in the underlying equity, meaning that I have a negative outlook on the company. Nothing in this article should be construed as legal advice and all the information represents the sole opinion of the author.