A Call for Yelp

By Chad Henage - July 13, 2012 | Tickers: ANGI, AAPL, GOOG, YELP | 0 Comments

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I recently read an article by Sean Williams of The Motley Fool about companies that are seeing a rise in short interest. One company that caught my attention was YELP (NYSE: YELP). As an Internet company that specializes in social review I can see why shorts might be immediately attracted to shorting the stock. Sean pointed out that not only is YELP reliant on advertising for income, but he also compared YELP to Angies List (NASDAQ: ANGI) which asks members to pay for a service that they can get for free elsewhere. His basis for agreeing with shorts is with low barriers to entry, and a high stock price that this stock could be a good short candidate. While I appreciate Sean's articles, he and I disagree on this one.

Angies List It's Not:

There are a few problems with Sean's position on YELP. First, the comparison to Angies List is unfair. While he points out that Angies List has been losing money for “16 plus years”, Yelp does not charge a fee to use the service. Angies List charges between $1.75 and $4.40 per month depending on what you want access to. In addition, unlike Angies List which isn't expected to turn a profit in the next couple of years, YELP is expected to turn profitable in 2013. The second issue with Sean's analysis of the company is he says that there is virtually no barrier to entry. While it's true that any company could start its own local review service, this service would take a while to catch the over 80 cities that YELP is already in. The company launched 11 new cities in just the first quarter alone. Looking at YELP's most recent earnings report and conference call gives investors insight into how the company expects to compete in the future.

New City Launch & Research:

First and foremost, YELP doesn't just start covering a new city on the site without preparation. The company first creates business pages for local companies, and then sends people out to double check addresses, phone numbers, etc. Then before launching the city, the company gets a community manager which is someone who is local and knows the city. This manager organizes meet-ups and supports YELP reviewers for their area. This is far beyond what other sites do, which is basically they import information from a local directory and if it's wrong, they don't correct it. I've personally found businesses on many web sites that didn't exist anymore, or their contact name or phone number was completely wrong. This additional information gathering by YELP gives the company a competitive advantage.

Local Advertising Is Different:

One common misconception about YELP is that the company competes for the same advertising dollars as all of the other web sites. While this is partially true, this is not the majority of YELP's business. From their recent earnings call, the company explained that 91% of their revenue is actually from “Local Revenue”. This segment's income is from enhanced profile pages for businesses, as well as performance and impression based advertising. In plain english, the growth engine of YELP is the local business owner. While companies like Google (NASDAQ: GOOG) are heavily reliant on advertising for the majority of their revenue and income, YELP is going after the local advertiser, not the huge multi-national company. Google makes a very good living by relying on advertising dollars and is expected to continue to grow by nearly 18% over the next few years. YELP also relies on advertising, but is expected to grow by over 100% in EPS in the next two years. To give you an idea of the size of the opportunity in front of YELP, the company is expected to report revenue of about $180 million next year. Local advertising is an over $130 billion business and only 15% of that is being spent online. As more and more customers search for businesses online, this spending will shift to more online advertising.

The Apple Integration:

There might not be bigger news for YELP than Apple's (NASDAQ: AAPL) recent announcement that YELP would be integrated into Apple's new maps application for iOS 6. The fact that just 6.3 million people are currently using YELP per month on mobile devices is going to increase. Consider that in just the last two quarters Apple has sold over 72 million iPhones and all of these users will have access to YELP in just a few months. YELP's business is destined to move toward mobile. It only makes sense that users are going to search for businesses while they are out. The ability to search for businesses and get YELP reviews can only help the recognition of the service.

Outlook For The Future:

The company's second quarter guidance of revenues of $29 to $31 million is right in the middle of analyst estimates of $30.69 million for the quarter. Full year guidance was a bit weaker than estimates as the company expects $128 to $132 million in revenues versus the average estimate is for $131 million. That being said, these numbers are from the company's guidance without any improvement in numbers from the upcoming iOS integration. It is quite possible the company's guidance could increase once this change is realized. Investors should be encouraged by two different statistics that were mentioned on the conference call. First, YELP has a very high customer repeat rate of 70%. When 70% of customers come back to use the service again, the company doesn't have to worry about customers leaving one review and not coming back. Second, and even more impressive is the company's growth in local advertising, which is speeding up as they enter new markets. Consider for a minute that markets entered in 2005 – 2006 showed local advertising up 71%. The markets entered in 2007 – 2008 saw a jump of 102%, and markets entered in 2009 – 2010 saw an increase of 148%. You can see, as the company gets bigger, name recognition helps more users to go to the site first. As more businesses realize that customers are flocking to YELP for reviews, smart local business owners will adjust their advertising spending accordingly.

Conclusion:

There is no question that YELP isn't for the faint of heart. At about 275 times 2013 estimated earnings, the stock is very pricy. However, game changing companies grow fast, and their future P/E can change very quickly. With a market cap of just $1.52 billion currently, YELP could also be an acquisition target before it reaches critical mass. I would stick with the old Peter Lynch rule of make sure the company can turn a profit before you invest, but this is one that should be on your Watchlist. The local advertising market is 85% offline, but many customers search online even for local businesses first. As business owners realize they need a good place to set up their virtual storefront, YELP could be an attractive location.

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