Why We Revised Our Price Estimate For Yelp To $38

Yelp’s (NYSE:YELP) stock marginally outperformed the broader market for much this year. However, the stock has outperformed the market in the last month, increasing by more than 30%. The primary reason for this has been the upward revision in the company’s revenue guidance for 2017. Furthermore, as the company has wound down its international operation to concentrate on the U.S. hyper local markets, its SG&A costs are expected to decline as a percentage of revenues. Based on these factors, we have revised our price estimate for the company’s stock upwards to $38, which is still below the current market price. Below we explain the factors supporting our valuation of the company.

Check out our complete analysis of Yelp

Local Ad Business To Grow, Albeit At Slower Pace

According to our estimates, the local ads business makes up 76% 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. According to the company, online local ad spending in the U.S. is expected to reach $149 billion in 2017. The company has a total addressable market (TAM) of 20 million local businesses in the U.S. However, the number of active advertising businesses, which pay for Yelp’s services, listed with the company is just a fraction of this market at 148,000 in Q2 2017. While we expect that the base effect will limit the active business listing CAGR to 10%, we believe that the company can add at least 165,000 active business accounts by 2024. Our reasons for this growth are as follows:

• Mature Cohorts Conversion: The number of claimed businesses, which have listings with Yelp but do not pay for any of the premium services, stands at over 3.8 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.
• Popularity of Yelp’s Mobile App To Attract More Businesses and Users: Yelp’s mobile app has gained traction in recent quarters; for example, in Q2 2017, monthly mobile unique visitors grew to 102 million, while 56% of its 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 that adoption of Yelp’s mobile platform will drive this growth in unique visitors, which in turn will lead to more businesses signing up with Yelp.

Average Revenue Per Active Business To Grow

Average revenue per active local business (ARPALB) is one of the most important drivers in our valuation for Yelp’s local 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 web pages and calls to action to promote their products or services. The company’s ARPALB improved to $11,322 for regions where Yelp started offering services in 2005, and to $929 for regions where Yelp services started in 2010. ^[1] We expect this to improve further in the coming years and the blended ARPALB (across all businesses) to grow to over $6750 per year.

Profitability Set To Improve

The single most important factor that drives Yelp’s value after its revenue growth is the growth in its operating expenses. Earlier, Yelp had to incur high operating expenses to fuel its rapid international expansion. However, as the company has exited international markets, we expect that expenses related to sales & marketing, which accounts for close to 50% of revenues, will decline to around 39% of revenue by the end of the forecast period. This will improve Yelp’s cash profits in the future.

Competition Can Impact 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 existing markets in the U.S. Although Yelp has a first mover advantage in social local review services, other Internet giants can leverage their data, experience, and money to launch similar services in the future. Companies such as Google (NASDAQ:GOOG) and Facebook (NASDAQ:FB) have competing services, and there is always the risk of these companies can expand and leverage their existing bases to compete with Yelp. As a result, Yelp’s revenue growth could slow down.

Our price estimate for Yelp stands at $38, which is around 12% below its current market price.

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1. Yelp Q2 2017 Investor Presentation [↩]