Yelp Is Worth $30 Per Share

Yelp’s (NYSE:YELP) stock has fallen out of favor with the investors and the price has declined by over 50% in the past six months. As a result, the stock has also under-performed the broader markets. While the return on Nasdaq has been 0.4%, Yelp’s return has been -53.2%. The primary reason for this has been failure of Yelp’s management to achieve street analysts’ estimates, who were expecting a much higher growth rate than Yelp was able to deliver. Furthermore, Yelp’s efforts to sell itself also failed, which further resulted in stock price decline over the past two months. However, we estimate that with the current growth rate and revenue run rate, from existing signups, the stock is fairly valued at $30.29. The company operates in geographies gives it access to over 76 million local businesses. As the company expands into new regions, its margins and monetization rate will be negatively impacted. Nevertheless, it still remains a dominant player in the $130 billion local ads business market, and should continue to rule the roost in the coming years. However, competition from Facebook and Google is intensifying, which is hurting Yelp’s growth potential. In this note, we explore factors impacting Yelp’s valuation.

Check out our complete analysis of Yelp

Local Ads Business Is The Key To Growth

According to our estimates, the local ads business makes up over 73% of Yelp’s estimated value. The key drivers for this division are the average revenue per active local business account 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 the Americas and Europe. This translates into a global market of nearly $130 billion. According to BIA/Kelsey, online local ad spending in the U.S. is expected to increase from $31 billion in 2014 to $35 billion in 2015. ^[1] However, the number of active business, which pay for Yelp’s services listed with the company, is just a fraction of this market at 90,200 in Q2 2015.  While we expect that the base effect will limit the active business listing CAGR to 30%, we believe that the company can add at least 359,390 active business accounts or 4.5% of 7.98 million claimed businesses by 2022. Our reasons for this growth are as follows:

• Mature Cohorts Conversion: The number of claimed businesses, which have a listing with Yelp but do not pay for any of the premium services, stands at over 2.34 million. Most of these businesses are in regions where Yelp has been operational for more than five years. Considering that mature markets witness higher conversion rates from claimed businesses to active businesses, we expect strong growth in active business accounts from these regions.
• International Expansion to Help With Growth: One of the key to Yelp’s growth has been its expansion in the international markets, which not only increases the cumulative reviews on the Yelp site but also increases its appeal to advertisers and users alike. Recently, the company added Malaysia and Phillipines to its addressed markets. As a result, the number of international reviews and traffic for the company has increased. While the company has grown over 40% year over year to approximately 30 million unique visitors on a monthly average basis, international reviews contribute 11% to the total reviews on the site. Furthermore, the company said that revenue from international markets is expected to gain traction in the coming quarters as it monetizes regions such as cohorts in Italy which were setup three years ago. We expect this expansion spree to bolster the number of active business accounts on Yelp in the coming years. While we expect that the base effect will limit the active business listing CAGR to 30%, we believe that the company can add at least 423,000 active business accounts by 2021.
• Popularity of Yelp’s Mobile App To Attract More Businesses and Users: Most of the users have a tendency to check up on local businesses particularly restaurants when they are on a move. As a result, Yelp’s mobile app has gained traction in the recent quarters. For example in Q2 monthly unique visitors grew to 162 million. Furthermore, 51% of these unique visitors (~82 million monthly users) used mobile devices for accessing Yelp’s services. Additionally, 55% of new reviews and 56% of the ad impressions 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 in the coming years. We believe adoption of Yelp’s mobile platform will drive this growth in unique visitors on the Yelp site, which in turn will lead to more businesses signing up for Yelp. This will also help the company to improve Average revenue per active local business (ARPABLB).

Average Revenue Per Active Business To Grow, Albeit At A Slower Rate

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, the monetization rate of a city or region increases with time as more businesses sign up for premium services such as dedicated webpages and call to action to promote their products or services. The company’s ARPALB improved to $7,449 for regions where Yelp started offering services in 2005, and to $546 for regions where Yelp services started in 2010. ^[2] However, as Yelp introduces its services in new regions, we expect ARPALB to grow at a slower pace, as new regions such as Latin Americas have less spending power compared to the U.S., and fewer businesses in these regions are willing to pay for premium Yelp services. As a result, we expect that the blended ARPALB will grow at a slower rate.

Points Of Concern

While Yelp has had some success in monetizing the local ads business, it does face some challenges that can impact its valuation:

• Competition to Impact Revenue 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 a first mover advantage in social local review services, other Internet giants are leveraging their data, reach and capital to strengthen their offering for local business search and discovery. Companies such as Google (NASDAQ:GOOG) and Facebook (NASDAQ:FB) have competing services, and are adding features that improve communication between local businesses and users based on the geographical location of the consumers.
• Expansion To Impact Margins: 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 the 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 have assessed the impact of assimilation of Eat24 and SeatMe businesses. This assimilation will positively impact the topline by $20 million in 2015 but may further erode profitability due to restructuring charges. Our price estimate for Yelp stands at $30.29, which is 30% above the current market price.

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1. U.S. Local Media Forecast, www.biakelsey.com [↩]
2. Yelp Q2 2015 Investor Presentation [↩]