Yelp Inc Still A Solid Value Play Following Earnings Rally

  • Yelp delivered solid sales results despite weakening profitability.
  • The repositioning of ad products and sales momentum reasserts my positive bias.
  • I’m initiating focused coverage with a price target of $33.60.

(Yelp (NYSE:YELP) performed a lot better on revenue than what the consensus was anticipating, as the company improved monetization through higher ad pricing and growth in local advertising accounts (LAAs). While, the improvement in revenue was unanticipated by investors, I figured the incremental advertising spend in conjunction with growth in its sales force would translate into some revenue acceleration, as q-o-q sales were above historical trends. That being the case some analysts are still on the fence with regards to Yelp, as the earnings results aren’t perceived as being sustainable given the one-time effect of introducing advertisers via promotional activities at the low-end. Furthermore, the growth in LAAs seems to have offset the usual attrition, which could be a positive sign assuming the management team is able to execute at a high-level given incremental spend in its sales force and on-going efforts to drive adoption in its mobile application as opposed to mobile web.

The company increased its FY’16 guidance range, albeit modestly from $685 million - $700 million to $690 million - $702 million. The adjusted EBITDA range was increased from $93 million - $105 million to $90 million - $105 million. The company reported revenue of $158.6 million, which compared to analyst consensus of $155.57 million. The beat on revenue was what drove the stock price over the past couple of weeks as the perception of diminishing growth has abated. I continue to like the stock despite questionable bottom line metrics, as the company reported EPS of $(0.20), which is indicative of Yelp’s continued emphasis on growing top line as opposed to improving profitability. The company’s adjusted EBITDA figures will likely come in-line over the next couple quarters, however, it’s uncertain whether a reported EPS beat will have any meaningful impact on the stock. Investor expectations are mostly tied to the company’s sales.

The CFO, Geoff Donaker mentioned on the earnings conference call that they’re repositioning ad-technology development to be more suitable for agency/large advertiser spend:

Youssef, thanks for your questions. First off, on the national buyer and our ROI tools, yeah, in fact, in the last few months, we've introduced a number of new product features for national buyers that I think have been helpful to the business. I'd say we're still on our early innings in terms of providing the right level of product support for that sophisticated national buyer. But we have done a number of things to improve the experience for them.

For the most part, I believe these efforts are more indicative of whether earnings/sales growth will remain sustainable over the long term, as large accounts are more profitable to service, and have better retention metrics as opposed to SMBs (small-medium businesses). The self-serve platform caters to SMBs, but given the high reported failure rates of businesses and the high dependence on organic traffic, the management team has readjusted accordingly.

5-11-16 Yelp

Source: Yelp

That being the case, the product has improved in terms of functionality as the lead generating capabilities don’t involve a high converting landing page, as Yelp provides the back-end web infrastructure. In the case of Google Search and Facebook (NSDQ:FB) a web presence is still required for lead conversions whereas Yelp is able to circumvent some of this given pre-existing business profiles.

While some ad formats have been introduced by Facebook and Twitter (NYSE:TWTR) for lead generation purposes, I feel Yelp’s platform is better suited for service organizations wanting to generate initial outbound interactions. Furthermore, leads are generally perceived to be more valuable and maintaining a high-performing sales funnel is easy/intuitive for many small and mid-sized businesses to rationalize on-going advertising spend.

Commentary among the analyst consensus was mixed coming out of the quarter. Here are a couple examples from the analysts I receive research from:

Updating for 1Q results, we raise our FY 2016e and 2017e revenue by 1% and 3%, respectively. Our upward revenue revisions are driven by better than expected sales productivity, which drives a 4% and 6% increase in our 2016 and 2017 local advertising revenue estimates. We raise our 2017e EBITDA by 2% as we expect some of this improvement in sales productivity to drop to the bottom line. We maintain EW, and $19PT. – Brian Nowak from Morgan Stanley

We continue to believe Yelp could enter a period of slowing topline, coupled with margin pressures, with concerns around traffic growth & the rising costs of growth (marketing, salesforce, tech innovation/engineering, International investment, etc.). New FY'16 estimates are revenues $702mm (from $690mm), Adj. EBITDA $96mm (from $90 mm), & GAAP EPS ($0.31) (from ($0.33). Valuation: Maintain Sell, Price Target of $17 (unchanged). – Eric J. Sheridan from UBS

YELP has been one of the biggest underperformers in the ‘Net sector, down 47% in 2015 and 25% YTD. Seems way excessive to us. Especially if YELP Local Advertising Revenue growth is at a positive inflection point. Which we believe it may be. We also see current valuation (9X ’17 EV/EBITDA) as potentially dramatically attractive, with limited downside (cash = 20% of mkt cap) and material upside (50%) within 12 months. We value shares of YELP using a 3.0x P/S multiple and 15x EV/EBITDA multiple on our 2017 estimates to arrive at our $36 price target. – Mark Mahaney from RBC Capital Markets

Transactions business continues to show momentum with revenue contribution of $14.5 million, growing more than 150% yoy. Hiring and retention trends at YELP continue to show improvements and sales headcount growth once again accelerated to 44% vs. 42%/35%/30%/28% seen in 4Q15/3Q15/2Q15/1Q15 respectively. Our FY16 revenue and adj. EBITDA estimates are now $691.1m/$99.0m vs. prior $684.5/$90.0m. Our $46 target price is based on discounted cash flow, using an 11% weighted average cost of capital and 3% terminal growth rate. – Stephen Ju from Credit Suisse

Much of the confusion really comes down to valuation. On one hand, there’s no denying that Yelp is attractively valued when compared to other dot com peers. However, the company has struggled with sustaining sales growth at respectable rates, which points to some management execution risk. In the immediate near-term there’s a high likelihood that Yelp will outperform when compared to some of its peers given efforts to reposition the product, and growth in some of its adjacent app properties.

However, there’s no denying the low-visibility on sales and whether costs will realign to a GAAP break-even point in the immediate three-year period thus making it difficult to value on a comparative basis to industry benchmarks/peer group. However, I view the uniquely differentiated app opportunity, and the attractive valuation when compared to other properties a compelling enough reason to stay the course with regards to Yelp.

I’m raising my initial recommendation from buy to high conviction buy. I’m assigning a price target of $33.60, which is based on a 12.5% discount rate attached to an end of five-year valuation of $4.64 billion. Furthermore, investors can capture added upside from here despite recent price action following the earnings report.

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  • I do not have any business relationship with the companies mentioned in this post.
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