Yelp Faces an Uphill Battle

Ishfaque is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Shares of the online consumer review company, Yelp (NYSE: YELP), got battered after its Q3 earnings release.  Yelp operates in an extremely competitive environment in the Local Ad space by connecting consumers with local businesses. It broadly competes with almost all of the leading search engines and a number of smaller regional companies for Local Ad dollars and commerce based deals. Intensified competition and low margins have impacted Yelp's bottom line, and it has not swung to profitability yet.  

Revenue stream

Yelp’s revenues come in mainly from the Local ad space consisting of performance and impression based advertising and enhanced profile pages which amounted to $28.5 million. Local revenue was 78.3% of total revenues, whereas the revenues from brand advertising were $5.9 million, and the rest was from Yelp deals which stood at $2 million.

Revenues are growing rapidly, but profitability hasn’t gained any ground at all. Top line growth for Yelp has been stellar, but mainly due to its small size and aggressive sales and marketing. Yelp’s expenditure on the Sales and Marketing front has been roughly ~63% of its total revenue in the first nine months of 2012.  

Gaining momentum in mobile

Yelp made material progress in its mobile ambitions thanks to Apple’s (NASDAQ: AAPL) integration of the Yelp mobile app in the iOS 6 system, and also the integration with Apple Maps aided to stimulate user engagement and acquire more user eyeballs. In Q3 2012, more than 8.2 million people accessed Yelp through a mobile device which represents Y/Y growth of 64%. In addition to Apple’s iOS, a substantial amount of traffic came from Android users as well. Growth in the number of mobile devices coupled with expansion in Europe will provide the additional tailwind to drive Yelp’s mobile traffic.

A staggering 45% of all Yelp’s search queries are conducted on mobile devices, and management indicated on the Q3 conference call that the click-through rate on mobile devices is significantly higher than on desktop, which would help in attracting more businesses to advertise on mobile when it starts rolling out local ads on mobile devices.  

International ambitions

Yelp currently doesn’t generate any revenue from its international locations, but has made investments to turn that around. Yelp acquired another cash burning business in the form of Qype, and it is closing down the ‘Email Deals’ unit of Qype. Qype will provide Yelp with a lot of traffic and online content to get access into key strategic markets such as Brazil, Germany, UK etc. However, Qype will only aid in top line revenue growth and cause net losses to expand even more.

Intensely competitive landscape

Google’s (NASDAQ: GOOG)  integration of Google+, Google Maps, Zagat Survey and Frommer’s to form Google+ Local will surely give Yelp a run for their money. Google had its sights on the local content for a while now, it had previously attempted to acquire Groupon (NASDAQ: GRPN) and Yelp before, so the tech behemoth is pretty adamant in its ambitions.

In 2011, ~42% of Yelp’s reviews came from restaurants alone. Zagat Survey ran as a paid subscription service and recently Google has made the service free on its search engine. Detailed ratings, reviews, photos and directions in the map pop up in the top right hand corner, once a user searches for the name of a restaurant that has been reviewed on Zagat. In addition, the Google+ Local service connects users with recommendations from friends on Google+ who have visited and wrote a review on Zagat Survey, thus gaining more credibility compared to taking advice from complete strangers.

Yelp’s revenue model of hiring a large sales force to sell ads and commerce deals to local businesses is very similar to the one employed by Groupon. Yelp competes with Groupon for local deals, and at the end of Q3-2012, there was more than 40,000 deals on Yelp.com.

However, Groupon operates at a much higher volume of sales, has a more diversified product portfolio and a larger cash hoard to operate with relative to Yelp. After Yelp’s deal with Qype closes, its cash position will fall below $100 million, and recurring net losses can cause incremental damage to its cash balances.

The Bottom line

Yelp operates in a business which does not have a durable competitive advantage. In addition, small business owners are a lot more likely to pursue direct mail and other forms of traditional offline advertising, and are also more skeptical of using their small advertising budget online.

In addition, the scary part is a disproportionate portion of Yelp’s traffic comes from Google’s search function. Google, being the clear-cut 800 pound gorilla in the Internet space, has already ramped up its pursuit of local advertising dollars.

An unprofitable company with strong revenue and user growth will likely be a takeover candidate. While an acquisition is possible, but the chances of that coming to fruition is very minimal and because of Yelp’s dual class structure which hands the company’s insiders ~96.7% of voting control.

Putting the pieces of the puzzle together, one thing is for certain, substantial headwinds lie ahead.

 


Fool Blogger Ishfaque does not own shares in any of the companies mentioned in this article. The Motley Fool owns shares of Apple and Google. Motley Fool newsletter services recommend Apple and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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