Yelp Earnings: Revenue Guidance Revised Downwards To Hit Stock Price

Yelp (NYSE:YELP) reported its earnings for Q2 FY15 on July 28th. The company once again posted growth as revenues increased by 51% year over year to $133.9 million. Yelp reported a sequential and year on year decline in net income to a loss of $1.35 million. However, adjusted EBITDA improved to $22.73 million compared to $17.24 million in the prior year quarter. As stated in our pre-earnings note, the company continued to report sub-par growth. Most of its performance indicators declined on a sequential basis, albeit they were up compared to Q2 of last year. Furthermore, the company lowered its revenues and EBITDA guidance for the year. As a result, the stock was down by over 20% in after market hour trading.

While the company reported 35% year-over-year growth in cumulative reviews to 83 million, the sequential growth was stalled at a paltry 7.8%. Furthermore, while average unique monthly visitors grew by 6% year over year to 143.9 million, it was flat on a sequential basis, indicating user and business fatigue. Engagement on mobile devices increased as unique visitors from mobile grew to 83 million during the quarter. Overall, we are disappointed by Yelp’s results and think that the business seems to be maturing as organic expansion has taken a back seat. We have revised Yelp’s price to $30.29, 40% below our previous estimates, based on the new guidance given by the company and its inability to control its sales and marketing expenditure, which forms a makor chunk of its operating expenditure. Below we review Yelp’s Q2 FY 15 results by segment.

Check out our complete analysis of Yelp

Outlook for Q3 and 2015 Revised Downwards

For Q3 FY15, the company expects revenues in $139-$142 million range, representing growth of approximately 37% compared to the third quarter of 2014. Adjusted EBITDA is expected to be in the range of $12 million to $15 million. For the full year, Yelp has guided that revenues will grow at a slower pace and projects net revenue between $544 million and $550 million (compared to $574 million and $579 million earlier). The primary reason for this is the phasing out of Brand advertising. Given that brand is relatively high margin, lower brand revenue will have a disproportionately large effect on adjusted EBITDA, which is reflected in Yelp’s lower outlook for full year 2015. As a result, adjusted EBITDA is also revised down to $72 million -$78 million compared to $102-$105 million range earlier. This downward revision soured market sentiments and the stock price declined by over 20% in after market hours.

Revising Price To $30.29

Based on the Q2 results and the trend in the first half of 2015, we have revised our price of Yelp to $30.29. The single most important factor that drives Yelp’s value after its revenue growth is the growth in its operating expenses. Yelp has had to incur high operating expenses to fuel its rapid expansion. Historically, Yelp’s operating expenses have been 85% of its overall revenues. It was close to 84.68% in Q2. While SG&A expenses account for 72%, R&D expense accounts for 16% of the revenues. Given the current situation and its ongoing efforts, we now expect sales and marketing costs to decline to around 47.75% of revenue by the end of the forecast period. This will reduce Yelp’s cash profits in the future. Furthermore, despite growth in topline, its gross margins have also declined due to higher cost of revenues related to network cost, which is increasing due to expansion.

We have also revised our estimate for deals division due to assimilation of Eat24 and SeatMe businesses. This assimilation will positively impact the topline by $20 million in 2015.

Local Ads Division Performance

The local ads division makes up 73% 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 FY15, active local advertising business accounts grew by 40% year over year to approximately 97,000, driven by international expansion underway and assimilation of Eat24 and SeatMe business, which enhances Yelp’s appeal to users and advertisers alike. Furthermore, the company said that revenue from international markets is expected to gain traction in the coming quarters as it monetizes these regions. The company expects to achieve revenue of $1 billion by 2017. However, as discussed earlier, we believe that as the company monetizes existing regions, and expands to new territories, its selling, general and administration (SG&A) and marketing costs will increase and lower the company’s profitability and cash flow as a percent of sales.

Mobile To Bolster Revenues

Unique visitor is one of the primary drivers for Yelp as it affects both its local ads business, deals and partnership and brand ads division, and during the quarter monthly unique visitors grew to 144 million. However, most of the growth was due to 22% growth in mobile unique visitors (~83 million monthly users). In Q2, more than 70% of its page views were from mobile app. Additionally, 65% of all Yelp’s searches were via mobile and mobile app installation grew by to ~18 million users. Considering the rampant growth in the usage of mobile devices, we expect the mobile platform to become a major revenue driver for Yelp in the future. 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 the adoption of Yelp’s mobile platform will drive this growth in unique visitors.

We have revised our price estimate to $30.29 for Yelp, which is 10% above with the current market price after the trading hours.

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