Yelp: Time to Burst the Bubble

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

Yelp (NYSE: YELP) seems to be achieving a lot of headlines before its earnings, as the stock has already gained 12% since last month. While investors are growing increasingly positive about this location based review firm, I believe that the stock is destined to go down the drain. Here is my thesis:

High Competition From Big Players and Small Players Alike:

While the Yelp bulls do not believe that its business will flourish in the long term, there are plenty of other players in the market that can take the place of Yelp, even now. Companies like CitySearch and Google (NASDAQ: GOOG) owned Zagat and Google local are going strong even as I write this piece. Add to that the advantage that Google enjoys as it cuts down the traffic to Yelp by bypassing the traffic to Zagat. This has been evident from the way that Google places the search results on their search pages as Yelp ends up considerably lower than Zagat.

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Yelp also faces competition from Amazon (NASDAQ: AMZN) which already has a strong presence with its Amazon Local business segment and its partnership in LivingSocial. With the resources and the technical expertise Amazon has in the area of reviews and recommendations, it could prove to be a tough competitor for Yelp in the near future. As if the competition from Amazon and Google was not enough, another big player, Facebook, has also been trying to get into the review market with its Graph Search. The graph search launch has already seen Yelp shares take considerable beating. Furthermore, the advances in the mobile based location services are also not helping Yelp in the way that investors predicted.  There are small firms like MyCityWay that are doing pretty great work in the mobile sector as they purely focus on the mobile user base and target everything from restaurant reviews and check-ins to deals.

Flaw in the Business Model

While Yelp has been increasing the number of users and advertisers quite significantly over the past, its failure to provide operating profits for suggests that Yelp’s business model might be inherently flawed as it tries to attract advertiser’s money. My reason is simple: Why would I pay my advertising dollars to Yelp if I already have good reviews and why would I accentuate my presence on Yelp if I have got negative reviews. As Yelp’s most important cohorts are not able to churn out profits with their internet savvy population, I wonder what would become of the new cohorts Yelp is expanding in.

Lots of Negative Reputation

With the constant competition Yelp is facing, it is becoming increasingly hostile towards the advertisers. Many small business owners complain that Yelp accentuates the negative reviews and filters out the positive reviews if they do not spend their advertising dollars on Yelp. While this strategy will force small and medium scale enterprise to come to Yelp in the short term, it will result in the skewing of data and will question the honesty of Yelp as a data intensive platform.

The Bottom Line

While this Earning season has strengthened the belief that US has entered a phase of economic recovery, odds still don’t look too good for the web 2.0 companies. Even the presence of the Yelp icon on iOS6 has not done the trick as Yelp continues to lose this competitive advantage with its bad monetization strategies. The increasing competition is a big threat which can hamper the future possibilities for Yelp even further. As Yelp could go down the way GroupOn has even if it delivers a fine quarter, I rate it as a sell.

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