Yelp Stock Is Still Just A Speculative Bet

  • Yelp stock has surged after a prominent activist investor revealed having acquired a minority stake in the company.
  • A recent Wall Street upgrade has also helped the Yelp stock.
  • Can Yelp stock maintain the current momentum and is now the right time to buy the shares?

Yelp (NYSE:YELP) shares are up 22.6% over the past one week after series of positive developments for the company. The first rally came after famous activist David Einhorn of Greenlight Capital disclosed that his firm had taken a minority 380K-share stake (less than 1% of Yelp) in the firm’s Q4 13-K filing. Einhorn is the activist investor who famously managed to force Apple (NASDAQ:AAPL) to change its capital allocation strategy.

5-Day Yelp Stock Returns

YELP-2

Source: CNN Money

It’s quite possible that Yelp investors see the presence of an activist shareholder such as Einhorn as a positive development that could help influence Yelp's management to accept calls to sell the company a la Yahoo (NASDAQ:YHOO). Yahoo finally bowed to activist pressure from Starboard to sell itself and is currently scouting for a buyer. Yelp’s management has in the past resisted calls by shareholders to sell the company. Yelp shares tanked badly in mid-2015 after the company declined merger advances from several companies.

Yelp resisted calls for a sale probably because the company thought its shares were significantly undervalued at the time. Back then Yelp had a market cap of $3B. But things have continued to get worse, not better, for Yelp. The company now has a market cap of just $1.4B, less than half of where it stood when it rejected buyout offers. Yelp stock is down 35% YTD and 61% over the past 12 months. Einhorn's Greenlight Capital is a large hedge fund with more than $10B in assets under management. The firm can conceivably increase its stake in Yelp to 5% or more without batting an eyelid. You can bet that it will have to take a major proxy battle for Yelp to even contemplate a sale when the shares have been hammered so badly. Einhorn, however, has his work cut out.

Merger speculations certainly have plenty of power to power up a dead stock. Groupon (NASDAQ:GRPN) shares have spiked more than 70% in a matter of days on news that Alibaba (NYSE:BABA) had acquired a 5.6% stake in the company, with reports later emerging that the Chinese online giant could be seriously mulling a merger.

Over the short-term there is a serious risk that Yelp shares might give up their recent gains if it later emerges that the company is not interested in a sale. The graph below shows what happened to Yelp shares the last time such a scenario unfolded:

Yelp-3

Source: Business Insider

The second wave of the Yelp rally has been fueled by a major Wall Street upgrade by Tigress Financial which has a Buy rating on the shares. Tigress Financial said that Yelp shares currently had an attractive risk/reward and that the local ad market presented an immense opportunity for Yelp.

But Tigress Financial’s sentiments are nothing new. Yelp certainly has what appear like good growth runways in the local ad market. After all, the company has millions of businesses listed on its site, but less than 1% have claimed their listings by advertising on Yelp. If Yelp can only manage to convince 5% of those businesses to advertise on its platform, then the company can go places.

But the big problem here is that Yelp still suffers from a major credibility problem and allegations of extortion. Whether this is merely a perception problem or not, the fact of the matter is that it’s bad enough to make 99% of the businesses on its site stay away from placing ads on the platform.

Yelp does not appear to have much of a growth problem, as evidenced by its latest earnings report where revenue shot up 40%. Yelp also gave pretty good guidance, saying it expects Q1 2016 revenue to grow in the low-30s percentage.

But growth for Yelp has been coming the hard way. You can guess as much from Yelp’s sales and marketing expenses, which have consistently been growing faster than its top line and badly pressuring profitability. Yelp grew its headcount by 45% during Q4 2015 while its S&M expenses jumped 63%, or close to 60% of revenue. So it appears as if Yelp products are a hard sell. This heavy marketing spend is the primary the reason Yelp has remained unprofitable for so long, and why Yelp stock tanked more than 12% after the company’s last earnings call despite a healthy beat.

Investor Takeaway

Unless you don’t mind playing a little speculation game, there is nothing that has changed fundamentally for Yelp to warrant buying the shares. There is no guarantee that we won’t see a repeat performance of last year if the company resists merger calls. Meanwhile, until Yelp can find a way to build trust with the millions of businesses listed on its platform, then the opportunity that Tigress Financial is talking about might only remain one in theory.

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Comments on this article and YELP stock

user profile picture
harshal.patel.1
bearish
Einhorn's stake is only worth $6million; hardly a drop for his hedge fund with $10bn in management. I highly doubt he'll devote much energy to Yelp.
3 1 reply
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