Yelp Earnings:Laps Up Profitability As Revenue From Core Local Ads Business Improves

Yelp‘s (NYSE:YELP) announced its earnings for Q2 FY14 on July 30^th and the company once again reported a rapid growth of revenues, as it grew by 61% year over year to $88.8 million. However, Yelp reported a substantial improvement in net income that grew to $2.74 million. Yelp’s Adjusted EBITDA also improved significantly to $17.2 million in Q2 FY14 compared to adjusted EBITDA of $7.7 million in prior-year quarter. The company continued to report good growth across all its performance metrics. The company reported 44% growth in cumulative reviews to 61 million, and 27% increase in average unique monthly visitors to 138 million. Additionally, the company also reported high engagement on mobile devices as unique visitor from mobile increased to 68 million from 45 million. While active local business accounts increased by 55% year over year to 80,000, claimed local businesses increased to 1.8 million. Overall, we are encouraged by Yelp’s results and think that the business seems to be on the growth path. Below, we review Yelp’s Q2 FY 14 results by segment.

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Outlook for Q3 and 2014

For Q3 FY14, the company expects revenues to be in $98 – $99 million range, representing growth of approximately 61% compared to the third quarter of 2013. Adjusted EBITDA is expected to be in the range of $18 million to $19 million. For the full year, Yelp has announced an improvement in guidance, and projects net revenue to be in $372 – $375 million range, while adjusted EBITDA should be in $67 – $69 million range.

International Expansion Boosts Revenues and Costs

The local ads division makes up 80% of Yelp’s estimated value. One of the primary drivers for local ads division is the number of active business accounts on Yelp. During Q2 FY14, active local business accounts grew by 55% year over year to approximately 80,000. The primary reasons for growth in this driver are the international expansion under way and the increase in cumulative reviews on the Yelp site, which increases its appeal to advertisers and users alike. Recently, the company added Japan and Argentina into its folds. As a result, international traffic grew over 80% year over year to approximately 31 million unique visitors on a monthly average basis. Furthermore, revenue from international markets now contributes nearly 30% to Yelp’s top line. We expect this expansion spree to bolster the number of active business accounts on Yelp to over 412,000 by 2020. However, we believe that as the company expands to new territories, its selling, general and administration (SG&A) and marketing costs will increase and lower company’s profitability and cash-flow as a percent of sales.

Deals Revenues Improves

Yelp’s deal, partnership and other services (DPO) division contributes 5.6% to its value. Currently, Yelp generates revenue from this division through any transaction that might occur on its website. Yelp’s deals platform allows merchants to promote themselves, and offer discounted goods and services on a real-time basis to consumers directly on Yelp’s website and mobile app. Yelp charges a fee on Yelp Deals for acting as an agent in these transactions. In Q2, Yelp reported 27% year-over-year growth in deals revenues to $4 million. We believe that the newly launched services such as call-to-action, which offers discounts and a delivery platform that closes the loop between discovering a business on Yelp are gaining momentum, and will drive revenues at DPO division going ahead.

Mobile Search To Bolster Brand Ads Division

Brand advertising is currently Yelp’s third largest source of revenue and makes up 4% of our stock price estimate. Yelp generates most of the revenues in this segment from display ads. The unique visitor is the primary driver for this division, and during the quarter monthly unique visitors grew to 138 million. However, 50% of these unique visitors (~68 million monthly users) used mobile devices for accessing Yelp’s services. During the quarter, 40% of new reviews came from mobile devices. Considering the rampant growth in the usage of mobile devices, we expect the mobile platform to become a major revenue driver for Yelp’s brand ads division. The growing number of consumers searching for local businesses online constitutes Yelp’s existing market, and in addition to company’s global expansion plans, we believe adoption of Yelp’s mobile platform will drive this growth in unique visitors on the Yelp site.

We are currently in the process of updating our Yelp model. At present we have a $56.22 price estimate on Yelp, which is 25% below its current market price.

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