Yelp (YELP) reported its earnings yesterday and shares are down almost 15 percent on Friday as the company's outlook was slightly below analyst estimates. Yelp, in contrast to other tech darlings like Groupon (GRPN), Zynga (ZNGA), and Facebook (FB), has successfully held its value since its initial public offering in March 2012. In this article, I explain why this might not last long, despite Yelp being a good company.
After today's stock price decline, Yelp is trading at around 10 times its expected 2012 revenue. Compare this to Groupon (1.04x), Zynga (1.62x), and Facebook (9.21x), and you see how Yelp shares could take a downward spiral. Yelp will still have a higher revenue multiple than Groupon and Zynga since its revenue is expected to increase at a faster rate, but its revenue multiple can easily drop below Facebook's, as Facebook is already very profitable and Yelp still has not proven that it can be profitable yet. I can see Yelp's revenue multiple entering the 5 to 8 times range in the next few months.
In addition to being worried by Yelp's revenue multiple, I'm also concerned about its expected revenue growth rate. Analysts expect 47.1 percent revenue growth from 2013, which is high considering that Yelp's revenue is up 65 percent year-over-year in 2012 and 74.5 percent in 2011. This big difference in expected revenue growth shows that Yelp is running out of networks to enter along with ways to further monetize its business. With this kind of decline, I can see Yelp revenue flattening out around the $500 million to $600 million range, which compared to competition would price the company in the $700 to $900 million dollar range, which is 35 percent to 40 percent lower than its current price.
Proving It Can Earn
The biggest problem with many tech darlings, with major emphasis on Groupon, Zynga, Angie's List (ANGI), and Pandora (P), is that they've struggled to be profitable when analysts first expected quarters in the black. Yelp, which had its initial public offering after all four of these companies, is expected to have its first profitable year in 2013 with an earnings per share of 6 cents. However, all of the aforementioned stocks were supposed to be somewhat profitable by now, just like Yelp is, yet all four are still struggling in the red. All four are flirting with profitability now, but none of them have proved that they can be a company that produces long term profitability.
It's highly likely that Yelp will continue this trend. Despite being expected to be profitable in 2013, I could picture the company's earnings per share staying in the -20 to -10 cent range. This could cause a major selloff among impatient investors and cause shares to drop off.
Yelp has become the market leader in user review websites. Cumulative reviews grew 49 percent in the last year to over 33 million (from the earnings report) and I believe this kind of review growth will be typical for Yelp going forward. However, there is a lot of upcoming competition that threatens to take market share from Yelp. Google has been drastically overhauling Google Maps to further promote user reviews. Its acquisition of Zagat showed its commitment to compete with Yelp. Google Maps is a much more accurate maps application than Yelp, its search function is proving better results than it has in the past, and it has a stronger position in the market, especially in the mobile market, with its search engine and Android operating system.
There are several other potential threats looking for a piece of Yelp's business. Other tech darlings like Groupon and Foursquare are looking for new revenue sources and have been trying to improve their local search and review services to gain access to new markets. Yahoo (YHOO) has not been very big on this space, but with Marissa Mayer at the helm, we can expect a stronger effort from Yahoo to revolutionize its local search and review services.
Despite Yelp being a very good company that so far has performed well relative to its counterparts, I expect a 20 to 30 percent haircut on the stock over the next year and give it a Sell recommendation. There is simply too much uncertainty around the company and its growth potential and I suggest staying away from shares for now. I believe short term at-the-money puts are the best way to short the company, although I personally don't like shorting good companies even if their shares are overvalued. If a major selloff occurs within the next few months, I will reevaluate the company and it is very likely my opinion of Yelp shares will change as I believe the company will still be a leader in the growing local search industry.