Contour Will Be Screaming for Yelp
Marshall is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Contour Asset Management, the $1 billion New York-based investment firm, snatched up some 1.6 million shares of Yelp (NYSE: YELP) earlier this month per an SEC filing. Contour is part-owned by Scandinavian hedge fund giant Brummer & Partners. Contour now owns approximately 5.1% of the social-review site, and joins the likes of major hedge funds Passport Capital and Joho Capital as major hedge fund owners of Yelp shares (check out Passport's portfolio).
The Yelp problem
Yelp is a social-review site, providing reviews and information about businesses, restaurants and local attractions. One of Yelp's biggest competitors is Google, and Google has no reason to play nice. After trying to buy Yelp in 2009, Google acquired Zagat and Frommer’s to enter the local-listings market segment. Google now competes with Yelp via its Plus Local service.
Google's social-review business is a minimal part of the company, but Google has all of the items in place to make the business viable. This includes a leading position in search and mobile operating systems. Google also has robust hedge fund interest, including the likes of billionaire Jim Simons, who's been snatching up shares of the company (check out Simons' buy ups).
Things get even worse when you consider the degree to which Yelp relies on Google to funnel organic search visitors to Yelp. Google's search results generate more than 50% of Yelp's search engine referral traffic. Google and Yelp testified in front of Congress back in 2011 related to Google's search methods. Yelp, at the time, believed that Google was a major threat to its business.
The other headwind for Yelp is its extensive sales force, one that cuts deep into revenue. This includes a sales team that offers businesses advertising-plan commitments. For 2012, sales, general and administrative (SG&A) expenses ate up more than 85% of revenue.
Even more problems
The competition gets fiercer than just Google. It appears that Facebook (NASDAQ: FB) is looking to break into the market with a rival restaurant-review service. As well, Facebook's Graph search is also a competitive pressure for Yelp. Facebook will be able to leverage data from its 1 billion-plus users for offering reviews and suggestions.
Facebook and Zynga (NASDAQ: ZNGA) once had a fruitful partnership, but Facebook has managed to break away from Zynga. Last quarter, there was a 37% decline in bookings from Zynga, which is still Facebook's largest game developer, yet Facebook still managed to see a 60% increase in game-related payment volume. Yet, unlike the Facebook-Zynga deal, I don't think it will be so easy for Yelp to break away from Google.
Zynga is world's largest social game developer with games that include FarmVille, Words With Friends and Mafia Wars, offering its game via Facebook, Yahoo, the iPad, the iPhone and Android devices. Revenue is generated from in-game sales of virtual goods and advertising.
The big news for Zynga, radiating the weakness and competitive pressures in the gaming market, is that the social-games company is slashing some 520 jobs in an effort to cut costs. The layoffs are upwards of 20% of its workforce, but are expected to save $70 million to $80 million. Even though the competitive pressures remain afoot for Zynga, analysts still expect the company to grow EPS by an annualized 20% over the next five years.
Meanwhile, Facebook is expect to grow EPS at a 29% compounded annual growth rate. Revenue for Facebook is expected to be up 40% in 2013, which should come as the advertising business continues to show strength. Facebook also has a solid balance sheet, with $9.5 billion in cash and only $1.5 billion in long-term debt.
Meanwhile, another high-profile recent IPO, Groupon, manages to bypass Google altogether by sending users deals direct via email. Groupon operates a shopping website, which offers goods and services at a discount in North America and internationally. It offers deals in health and beauty, retail, services, activities, events, and food and drink.
Going into 2Q, there were a total of 25 hedge funds long the stock, a 19% increase form the previous quarter. Of the hedge funds making bets on Groupon, the hedge fund owner having the largest position is Chase Coleman's Tiger Global Management (check out all of Tiger's small cap picks).
Among some of the the top IPOs of late, Yelp has outperformed some of its peers nicely. Since March 2012, Yelp is up more than 20%, while Groupon and Zynga are down more than 60%.
Even still, I remain cautious on the stock. Yelp's valuation is well above some of the other major tech companies. Yelp trades at a enterprise value-to-sales multiple of 11.8, compared to Groupon's 1.4, Zynga's 7.6 and Facebook's 9.
One possibility for Yelp is for the company to partner with with the likes of Google or Facebook. Otherwise, I fear that Yelp's business could be rendered useless. The real issue is; why would either Google or Facebook partner with Yelp? Google has already made its own segue into the industry and Facebook has access to enough data to make its own form of a social-review platform.
I think the competitive pressures for Yelp is robust and its over reliance on Google is still a concern. As well, compared to other major newly IPO'ed companies, Yelp appears to be overvalued.
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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool recommends Facebook. The Motley Fool owns shares of Facebook. 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!