Why is Yelp Worth $56?

In the last three months, Yelp’s (NYSE:YELP) stock price hit a historical high of $101.75 before falling to $50 levels. We believe that the company’s is fairly valued at the current market price of $57.31, which is also in line with our stock price estimate. While the key driver for company’s growth is its core local ads business, it has taken some prudent steps to shore up its deals business. In this article, we will explain the factors supporting our valuation of $56 and the risks that can hamper its growth.

Check out our complete analysis of Yelp

Local Ads Business To Grow Albeit At A Slower Pace

According to our estimates, the local ads business makes up over 80% of Yelp’s estimated value. The key drivers for this division are the average revenue per active local business accounts and the number of active local business accounts listed with Yelp. The company has a total addressable market (TAM) of 76 million local businesses in the world, of which 53 million are present in North America, Europe and New Zeland. However, the number of active business, the business that pay for Yelp’s services, listed with the company forms just a fraction of this market at 74,000 in Q1 2014. Furthermore, the number of claimed businesses, which have a listing with Yelp but do not pay for any of the premium services, stands over 1.6 million. Considering that mature markets (regions where Yelp has been operational for more than five years) witness higher conversion rates from claimed businesses to active businesses, we expect strong growth in active business accounts. We expect that the base effect will limit the active business listing CAGR to 30%, and believe that the company can add at least 400,000 active business accounts by 2020.

Furthermore, Average revenue per active local business (ARPALB) is one of the most important drivers in our valuation for Yelp’s locals ads business. According to Yelp, monetization rate of a city or region increases with time as more businesses enlist for premium services such as dedicated webpages and call to action to promote its products or services. The ARPALB improved quarter over quarter from $3,800 to $4,292 for regions where Yelp started offering services in 2005, and from $264 to $315 for regions where Yelp services started in 2010. ^[1] However, as Yelp introduces its services in new regions, we expect ARPALB to grow at a slower pace as new regions such as Mexico have less spending power compared to the U.S., and fewer businesses in these regions are willing to pay for premium Yelp services. We expect this trend to continue till the end of our forecast period in 2020, and project ARPALB to grow to $3,310 by 2020.

Deals Revenues To Improve

Deal, Partnership and Other services (DPO) division is Yelp’s second largest division and contributes nearly 6% to its estimated value. While this division has been slow to take off, Yelp took some prudent steps to monetize this division. Through the call to action and the delivery platform, the company is aiming to engage both the businesses and users alike. Call to action lets an active business owner market its product on Yelp, while delivery platform enables a user to order products directly from a business he or she has located on Yelp. These services have the potential to be big money churners in the future. Furthermore, the company has recently launched a free reservation tool for businesses that allows clients and users to book restaurant directly from Yelp’s site. ^[2] Therefore, we estimate that the revenues for DPO division will grow to $100 million by the end of our forecast period as Yelp’s delivery platform, product portfolio and transaction services gain traction. However, if revenues from these services do not pick up and increase to only $50 million by the end of our forecast period, our stock price estimate can decline by 10%.

Competition Can Challenge Yelp’s Growth

Our forecast is based on the assumption that Yelp will see reasonable success across its business lines and will be able to attract users in the new markets it enters. Although Yelp has first mover advantage in social local review services, other Internet giants such as Google (NASDAQ:GOOG) and Yahoo (NASDAQ:YHOO) have competing services such as Google Places and Yahoo! Local. There’s always the risk that these companies can expand and leverage their existing base to compete with Yelp. If this were to materialize, Yelp’s revenue growth would slowdown. This could hurt the stock as the high price to sales-per-share ratio (a bit over 24x) suggests that the market is mainly pricing Yelps’s stock on high expected revenue growth. The P/E ratio is less meaningful as the company is only now generating positive cash EPS.

Our price estimate for Yelp stands at $56.46, which is in line with its current market price. We invite the reader to adjust the model and create his or her own alternative valuation.

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1. Yelp Q1 2014 Investor Presentation [↩]
2. Yelp Reservations: New Free Tool for Businesses Gives Diners Even More Options When Booking Online, May 13 2014, officialblog.yelp.com [↩]