Does Yelp Need Help?

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

I think Yelp (NYSE: YELP) may need some serious help. The San Francisco-based online business review website missed fourth quarter estimates as expenses took at bite out of revenue. Does Yelp need to be taught a few harsh lessons in frugality before it crashes, like so many Internet and social media stocks before it?

A Growing Niche Market

Yelp is a search engine for local businesses, but its key feature is the ability to review businesses for peers across a social network. With integration with GPS technology in smartphones, Yelp can also provide reviews on the go. Yelp’s market is considered a niche market, primarily focused on local online ads -- a market that research firm BIA/Kelsey projects to rise from $21.2 billion in 2011 to $38.1 billion in 2016.

Some Ugly Numbers

For its fourth quarter, Yelp reported a loss of 8 cents, or $5.32 million, missing estimates by 3 cents per share. Revenue topped estimates, surging 65% to $41.2 million. However, sales and marketing expenses soared 59% to $25.5 million, gobbling up 62% of Yelp’s total revenue.

Those numbers certainly look hazardous to Yelp’s financial health. Let’s review the fundamentals to see how the company is holding up, and how it measures up to another high growth social media commerce stock -- Groupon (NASDAQ: GRPN).

<table> <tbody> <tr> <td><strong>Company</strong></td> <td><strong>Forward P/E</strong></td> <td><strong>5 yr. PEG</strong></td> <td><strong>P/S Ratio</strong></td> <td><strong>P/B Ratio</strong></td> <td><strong>Total Cash</strong></td> <td><strong>Total Debt</strong></td> </tr> <tr> <td><strong>Yelp</strong></td> <td>93.25</td> <td>60.49</td> <td>11.68</td> <td>9.74</td> <td>$123.8 million</td> <td>None</td> </tr> <tr> <td><strong>Groupon</strong></td> <td>22.50</td> <td>1.20</td> <td>1.62</td> <td>4.43</td> <td>$1.2 billion</td> <td>None</td> </tr> </tbody> </table>

Source: Yahoo Finance

Despite its recent troubles, Groupon is a better fundamental value, while Yelp’s lopsided fundamentals make it completely overvalued. Surprisingly, Yelp doesn’t shoulder any debt yet, but if its trend of posting losses continues, then this could change next year.

Let’s compare how Yelp’s stock has performed against its social media peers since its market debut last March.

<img src="" />

YELP data by YCharts

Surprisingly, Yelp has held up relatively well, near its breakeven point, outperforming high profile social IPOs Zynga, Groupon and Facebook (NASDAQ: FB).

The Classic Problem

Although comparing Yelp directly to other social media businesses isn’t absolutely fair, since they operate on different business models, they all exhibit the classic problem that their late 20th century Internet startup predecessors faced -- soaring revenue being outpaced by out-of-control marketing and expansion expenses.

Crunch these year-on-year numbers for fiscal 2012.

  • Yelp generated $137.6 million in 2012 -- a 39.5% increase.
  • Yelp lost $19.1 million in 2012 -- a 13% increase.

Let’s see how Yelp has fared in terms of revenue and earnings growth, as well as cash reserves and operating margins.

<img src="" />

YELP Revenue TTM data by YCharts

For now, Yelp is still generating revenue faster than it is losing money, but CEO Jeremy Stoppelman recently announced plans to expand into additional markets, which will increase expenses in 2013.

Can Yelp Thrive in Overseas Markets?

Stoppelman introduced Yelp to 26 new cities in 2012, and expanded into Poland and Turkey during the fourth quarter. Yelp is now available in 97 markets and 20 countries worldwide. While that kind of ambition is admirable, Stoppelman also noted that these new locations could take 18 to 36 months to start generating revenue and become earnings accretive.

While Yelp has enjoyed success in the United States, its potential in other markets is questionable. Many wired emerging markets, including China, already have their own restaurant review apps, which are synchronized to online reviews and Google (NASDAQ: GOOG) Maps. In addition, Google’s own star-based review system, which operates on the same principle, is also gaining popularity, and integrates more smoothly into Google’s own Android and desktop search systems.

Facebook's 'Check-In' feature, which now allows photos and comments for local businesses, is also a growing threat.

Domestic Strength

Despite these grand ambitions for expansion, Yelp’s core strength comes from local advertising. Yelp’s reach was greatly expanded by the popularity of Apple’s Siri voice search, which uses Yelp as a default business search engine. This allowed Yelp to profit from local advertising, especially from smaller businesses. As a result, local advertising revenue soared 87% to $33.9 million, accounting for 82% of total revenue.

Mobile Strength

Yelp has a distinct advantage over its social media peers -- while Facebook, LinkedIn and Groupon started on the desktop and migrated towards the mobile platform, Yelp’s business model was built for mobile access, since users will more likely search for restaurants on the go. Yelp’s mobile applications accounted for 46% of total traffic, used across 9.2 million unique devices monthly.

Yelp’s users are increasingly engaged in the site, as smartphones and tablets gain in popularity. Total reviews across Yelp’s sites rose 45% to approximately 36 million by the end of fiscal 2012. Average monthly visitors also rose 31% to 86 million.

To capitalize on this rising trend, Yelp introduced mobile ads in the fourth quarter -- 25% of its local ads are now displayed on mobile devices. I believe that recent mobile results from Facebook and Google, which have shown significant growth in the mobile advertising market, are encouraging for Yelp’s mobile growth prospects.

Bottom Line

Looking forward, Yelp expects to generate $44 million to $44.5 million in revenue for the first quarter of 2013, in line with the average analyst estimate of $44.3 million. Still, that’s a big step up from the $27.4 million it posted in the first quarter of 2012.

If Yelp can maintain double-digit revenue growth throughout next year, it will still grow its top line at a faster rate than its drop in earnings, which will keep its head above water. While no one expects Yelp to be profitable right away, investors need to be aware that its rapid expansion plans, especially into international markets, will weigh heavily on EBITDA for several years.

Google and Facebook, with their sprawling mobile integration, should also be watched closely, especially in overseas markets.

Yet Yelp has a distinctive advantage over these competitors. Like Facebook, Yelp is is likely to remain on top of its market simply because most people are accustomed to using it. Thus, local advertisers will continue using it to reach customers. That extremely desirable snowball effect could lead to exponential growth down the road. For now, however, Yelp is a fundamentally risky and speculative bet.

Leo Sun owns shares of Facebook. The Motley Fool recommends Facebook and Google. The Motley Fool owns shares of Facebook 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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