Tuesday, May 20, 2014

* YELP - Everything You Need; And Why this Company May be Overvalued

YELP closed trading today at $57.38, up small. The Symbol Summary is included below.

Charles Schwab optionsXpress

"[I]t's in the cracks and crevices [] but the accusations are out there, that YELP is a bully. That YELP is a cheater.

I like YELP the app. I use YELP. I rely on YELP. But YELP is not a $4B company as it's currently constituted. Not in my opinion. Operating margins are worsening quarter over quarter, are now and always have been negative, revenue growth has declined, and there isn't much more they can do with gross margins which are at impossibly high levels.

This is a valuation note that will follow nothing other than facts.  It's one of those pieces where I like the service, but the stock valuation is... rich?...  Let's have a discussion, fed by facts.

After that... we'll get into some uncomfortable accusations of less than ethical business practices.

First, here is the summary of it all:

Charles Schwab optionsXpress

This is a $4B+ firm with negative earnings.  But of course, a stock price is the Present Value of all future expected  free cash flows, so this moment in time with negative earnings doesn't automatically mean the firm is not valuable.  AMZN is worth $140B and just barely turns a profit at all (P/E = 470).


Annual Revenue


Revenue has been increasing at a huge rate, going from ~$48M in 2010 to now over $232M in 2013. The growth rate, looks like this:

All of those numbers are remarkable.  The dip from 2011 to 2012 was odd, but, hey, 2013 looked awesome.  In any case, 65%+ YOY growth is huge.

One of the great things about YELP is gross margins, they are incredibly high and incredibly consistent.

I mean, there's just not anything else you could ask for using this metric. But, that also means, if YELP is to turn positive (earnings), it's not coming from gross margin improvement.  So... good news / bad news here.

Let's take a look at revenue quarterly over the last year.


Again, nice numbers: the trend is in the right direction, i.e. up.  But... when we look at the quarterly revenue growth, we do see something that was hidden in the annual numbers.

We see a sequential drop in revenue growth quarter over quarter for what I believe is the first time ever. Gulp.

Now let's turn to annual operating profits.


So, the good news is, operating profit margins are growing (becoming less negative).  The bad news is, the company hasn't turned a profit... ever.

But again, that annual data is hiding something that the quarterly data reveals.


Look carefully at the bottom number relative to the top number.  Actually, here, I'll do it with you in a bar chart, below:

Yeah, what we see are worsening operating margins over the last four quarters, for a firm that has yet to ever create a profit, that is not a good trend.

Is this reality reflected somewhere else in the financials?  Yes, actually, it's in the return on equity:


That's annual data, and that's not a good trend.  The quarterly data shows decreasing operating margins while never having posted a profit, that's not good either.  But I'm not the only one that sees this; not even close.  Here's the stock chart for YELP over the last two-years.

So we can see the meteoric rise in equity price to, forgive me, ridiculous levels, and an abrupt turn back down.  At this price level, we are in the $4.1B market cap range.

So, yeah, the market sees that perhaps the valuation was... pricey... and that the news recently hasn't been "great."

But, here's where it kind of totally turns south for me (just an opinion).  It turns out ~20%-25% of Internet reviews (not just YELP) are false.  i.e. they are "ballot stuffers" raising the rating of a certain company by either the company itself, or those paid to do it by the company.

Here's an article that focuses on YELP, in particular:
The number of fake reviews on Yelp rose to 20% in 2013 from only 5% in 2006, according to a new report out of Harvard Business School.

The study, which we found on Market Watch, comes hot on the heels of The New York Attorney General's bust of 19 companies that specialize in publishing fraudulent online reviews, a process called "astroturfing."


But this big reveal just scratched the surface.

“The problem is definitely more widespread than the Attorney General’s investigation,” the new report's author, Michael Luca, warned Market Watch.

The rush for rave reviews may be growing as more businesses realize the power of Yelp's 108 million monthly visitors. Boosting a restaurant's rating on Yelp by even one star can increase its revenues by as much as 9 percent, according to a different study that Luca published in 2011.

Source: The BUSINESS INSIDER A Whopping 20% Of Yelp Reviews Are Fake, written by Jillian D'ONFRO

What's so compelling here is that YELP ratings actually matter: "Boosting a restaurant's rating on Yelp by even one star can increase its revenues by as much as 9 percent." Fantastic for YELP.

But that's a double-edged sword.  With that much on the line, some cheating is overtaking the service.  And if that remains the case, then what differentiates YELP from say, Google reviews (or whatever)?

That rise in false reviews from 5% to 20% (a triple) could be a peak, as there is a lot of effort being put forward to stop that type of behavior, or it could be the beginning of a disaster.  In fact, there are a number of articles that now show purchasing fake reviews for a business actually hurts performance, as users are becoming more keen to the stench of a false review, which tend to sound alike... a bit too glowing, a bit too happy, a bit too... false.

But there's some more bad news for YELP.  This article came out on April 4, 2014:
The FTC recently announced that it received more than 2,046 complaints against Yelp.

According to The Wall Street Journal, most of the complaints were lodged by small business owners alleging that Yelp posts fraudulent reviews that defame their reputation.


However, this was nothing new for Yelp, as it receives approximately six subpoenas on a monthly basis, demanding the true identities of the anonymous reviewers. Yelp vehemently denied the allegations and said that there is no relationship between reviews and sponsorship.

 Most of these business owners said that the negative reviews posted on the website appeared after they declined to pay Yelp for sponsorship.

Source: Zacks Equity Research Yelp Drops on FTC Complaints, Lawsuit

Now see, this story is actually pretty pervasive... but it's in the cracks and crevices of the Internet.  Even a Google search takes some time, but the accusations are out there, that YELP is a bully.  That YELP is a cheater.  And if that comes to light (if it's true), YELP is dead.

I don't think that will happen.  I like YELP the app (website).  I use YELP.  I rely on YELP.  But YELP is not a $4B company as it's currently constituted.  Not in my opinion.  Operating margins are worsening quarter over quarter, are now and always have been negative, revenue growth has declined, and there isn't much more they can do with gross margins which are at impossibly high levels.

The best case for shareholders would be a takeover -- that price would (could) be over $4B. But unless that happens, I think YELP is over valued... by a lot.

At the time of this writing, I am long a put spread in YELP. 

This is trade analysis, not a recommendation.

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