Yelp Q3 Earnings Preview: Local Ads Business To Grow On The Back Of Strong Mobile Adoption

Yelp (NYSE:YELP) is set to release its Q3 2015 earnings on Wednesday, October 28th. ^[1] Yelp’s stock has underperformed the broad market index over the past three months as less than expected growth in its core local ads business is impacting investor sentiment. Although the company continues to report good revenue growth, its performance metrics have grown at a decreasing pace — indicating that growth across its businesses is slowing down. However, most of the growth in Yelp’s business stems from the strong adoption of its mobile app. We believe that this trend continued in Q3 as its mobile user base increased. The pace of local ads growth slowed as well due to international expansion. In this earnings announcement,  we continue to monitor the monetization rate of its existing and new markets  (from both mobile and desktop ads) as it will help us ascertain revenue growth in the coming quarters.

Check out our complete analysis of Yelp

Outlook for 2015 and Q3

During its Q2 earnings announcement, Yelp revised its guidance for 2015 downward and projected net revenue between $544 million and $550 million (compared to its previous guidance between $574 million and $579 million). The primary reason for this was the phasing out of Brand advertising. Given that brand advertising 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. 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.

Growth In Mobile Ads Metrics To Boost Revenue

Most users tend to check up on local businesses, particularly restaurants, when they are on the 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 to access Yelp’s services. Additionally, 55% of new reviews and 56% of the ad impressions came from mobile devices. Considering the rampant growth in use of mobile devices, we expect the mobile platform to become a major revenue driver for Yelp in the coming years. We believe the adoption of Yelp’s mobile platform will drive growth in unique visitors to 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). In this earnings announcement, we will continue to monitor growth in unique user count for Yelp’s mobile app.

Growth In Local Ads Business To Continue, But Profitability A Concern

The local ads business currently accounts for around 73% of Yelp’s stock value, according to our estimates, and is its biggest revenue source. During Q2 2015, active advertising local business accounts grew by 40% year over year to approximately 97,000, slower than expected.

The number of claimed businesses, which have a listing with Yelp, but do not pay for any 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. Furthermore, the company had stated in its earlier announcement that the monetization rate for a mature cohort (region) is higher than the newer ones. Therefore, we expect average revenue per active business account, which is a function of the duration of Yelp’s services in a region, to grow during the quarter.

The primary drivers for Yelp’s account growth are international expansion and assimilation of the Eat24 and SeatMe businesses, which enhance Yelp’s appeal to users and advertisers alike. As the company continues to expand in international markets, we expect the active local business accounts to grow in the coming quarters. 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 the company’s profits and cash-flow as a percent of sales.

Our price estimate for Yelp stands at $30.29, which is 34% above its current market price.

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