Can These 2 Companies Grow in the Shadow of Google and Facebook?

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

It wasn’t that long ago when all hope seemed lost for daily deals site Groupon (NASDAQ: GRPN) and local recommendations site Yelp (NYSE: YELP). Google (NASDAQ: GOOG) and Facebook (NASDAQ: FB) had introduced new features that threatened to undermine their very existence. Google integrated its “Places” feature directly into Google Maps, and introduced a Groupon-like daily deals service, Google Offers. Not to be left behind by its nemesis, Facebook upgraded its “Nearby” feature to prioritize establishments frequented by friends, and offered limited-time timeline offers to compete with Groupon’s Daily Deals.

However, Groupon and Yelp have kept going, and both companies recently surged on stronger-than-expected quarterly results. Can these two companies keep growing in the shadow of Google and Facebook, or is it only a matter of time before the two internet behemoths shut these two smaller challengers down once and for all?

Finally, some good news for Groupon

Groupon surged 22% on Aug. 9, after the company named co-founder Eric Lefkofsky CEO. Lefkofsky had been serving as interim CEO since former CEO Andrew Mason was ousted in February. Earnings came in at $0.02 per share, down from the $0.08 it earned in the prior year quarter but in line with analyst estimates. Revenue rose 7% to $608.7 million, topping the consensus estimate of $606 million.

Revenue in North America rose 45%, but sales in the EMEA (Europe, Middle East, Africa) region declined 24% and sales from the rest of the world fell 26%. However, Groupon’s solid top line growth in its largest market was enough to convince investors that a turnaround could be in the cards for the company. Nearly 50% of the company’s North American transactions were made on a mobile platform, a 30% year-on-year increase which indicated that the company was not being left behind in the shift from personal computers to smartphones and tablets.

Total active customers rose 12% to 42.6 million, active deals rose 35% to 54,000, and total vouchers and products sold before cancellations and refunds climbed 15% to 46 million. To add some icing to that cake, the company announced a $300 million share buyback program over the next 24 months.

Yelp shows that it doesn’t need any help

Prior to Groupon’s robust earnings, Yelp edged towards profitability with its second-quarter earnings on Aug. 1. The company only lost a penny per share, up from the loss of $0.03 per share it reported in the prior year quarter. Analysts had expected a loss of $0.04 per share. Revenue soared 69% to $55 million, topping the $53.29 million that analysts had projected. As a result of these solid numbers, shares of Yelp surged 23% after earnings.

Yelp’s active local business accounts rose 62% to 51,400, while its unique monthly visitors came in at an average of 108 million. Cumulative reviews came in at 42.5 million. Like Groupon, Yelp reported solid growth in mobile, with 59% of total queries coming from mobile devices, where 40% of the site’s local advertisements were displayed.

Yelp has been concentrating heavily on expanding into international markets, especially crisis-stricken Europe. During the quarter, the company added Qype content from France and traffic data from Spain and Italy to enhance its services. Total international visits during the quarter climbed 75% from the prior year quarter and accounted for 16% of the site’s visitors, but overall international revenue still only comprised 5% of the company’s top line.

Partying in the shadow of Vesuvius

Although Groupon and Yelp definitely shrugged off the bears last quarter, there were still many questions that have been left unanswered. The combined threat of Google, Facebook, and other rivals should still be a top concern for shareholders in both companies.

Groupon has one glaring weakness against Google -- its relationship with merchants. Groupon generates revenue by asking merchants to list their products and services at steep discounts of 50% or more. The revenue from the sale is split in half with Groupon, leaving the merchant with only 25% of the initial sale. Merchants are then required to wait up to 60 days for their share of the revenue, even though Groupon claims the revenue immediately in the current quarter.

Google, through its Google Offers, has targeted this weakness by paying 80% of the merchant’s share of the revenue within four days of the initial sale. The remaining 20% will be paid within 90 days. Google also pays merchants for unused vouchers, while Groupon does not. Groupon also faces looming competition from e-commerce giants Amazon and eBay, which also showcase their own Daily Deals. Facebook has also introduced limited time offers in users’ timelines which can be claimed from participating companies.

Meanwhile, Yelp’s local-based peer review system for businesses was once an industry standard, but times are changing quickly. Simply take a look at this comparison of the most-used smartphone apps in the world during the second quarter.

Source: Mashable

If Facebook and Google continue to be the two most used smartphone apps in the world, it’s quite possible that location-based review sites on those two platforms could eventually render Yelp irrelevant.

Google has merged peer reviews with professional ones from Zagat, which it acquired in 2011, to create a more comprehensive look at local establishments. This has helped it avoid the accusations of bias and fake reviews that have constantly plagued Yelp.

Facebook, on the other hand, is emphasizing friends’ opinions over anonymous and professional ones. Facebook’s “Nearby” feature detects places frequented and reviewed by friends via check-ins. The company’s Graph Search feature also works with Nearby, providing a searchable database of a users’ friends’ favorite local businesses. Since many businesses now offer discounts to users who check-in at their businesses, this feature could easily snowball and crush Yelp’s core business.

The Foolish bottom line

Although Groupon and Yelp have finally shown Wall Street some positive top and bottom line growth, I’m not convinced of a turnaround. Google and Facebook are just getting warmed up, and I expect to see both internet giants make impressive gains in both daily deals and location-based recommendations in the coming year.

When that happens, Groupon and Yelp will be pushed off a cliff unless they can offer compelling reasons to stick with their services. In my opinion, the best outcome that Groupon and Yelp shareholders can hope for is a buyout from a company like Apple or Microsoft, which could fully integrate their services into their more developed ecosystems.

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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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