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Why Investors Should Avoid Yelp

August 15, 2014 | About:
JuhiKulkarni

JuhiKulkarni

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Local marketplace Yelp (YELP) is on a tear as far as revenue growth is concerned, posting a 61% year-over-year jump in the second quarter. However, the same cannot be said about the stock price. Yelp shares have appreciated just 3% in 2014, even though the company has reported rapid growth in its key metrics. It has been consistently reporting losses and has yet to register a profit and trades at an expensive forward P/E of 206.

The wrong strategy

Yelp has been reporting losses for awhile now, and the reason is that it has been spending lavishly to entice advertisers. Although the increasing marketing expense has resulted in consistent double-digit revenue growth, the company is not expected to turn profitable for at least another year. Yelp's current business model on spending lavishly on advertisers and generating lesser money is not sustainable, and the company's share price is destined to fall.

Moreover, Yelp is facing tough competition from Google+ Reviews. Google (GOOG, GOOGL) already has an edge over Yelp with its search service that acts like a one-stop shop for users and has integrated Google+ Reviews across its Google searches and Google Maps. Around 83% of searches were set with Google+ Reviews, promoting the app worldwide.

The problem with reviews

Reports suggest that one out of every five reviews on Yelp is fake, making it less trustworthy. This is due to the easy and less secure review filter of Yelp, which is easy to bypass. Yelp's review system is unable to detect a fake user if that user is moderately active. On the other hand, Google can track a user on other apps like Google Maps, Gmail, etc. to track and compromise counterfeit accounts. Google's quick and handy search methods make it more preferable than launching an app like Yelp. This is the reason why Google has a large user base. All these factors combined, Google+ reviews will have a stronger hand over Yelp.

In addition, Google's advertising program is much better than Yelp's, if you compare cost-per-thousand impressions, or CPM. Advertising cost for Yelp goes as high as $600, which is a big ripoff. Yelp's ads can cost 100-1,000 times more on a CPM basis than Google.

OpenTable's acquisition is nothing to get excited about

Yelp's share price had fallen almost 45% since March 2014. However, it started growing again on the news of the acquisition of restaurant reservation specialist OpenTable by Priceline (PCLN) for a hefty premium of 46%.

This acquisition has made investors believe that Yelp may also be an acquisition target for other companies. However, it is not going to happen. Yelp's valuation is too bloated to consider it as a takeover candidate. As I already said, the company isn't expected to report a profit until next year, and it has a towering forward P/E ratio. In addition, the P/S ratio currently stands at 18.11, which signifies Yelp's ridiculous overvaluation.

OpenTable seated over 46 million diners in the first quarter, registering a 25% increase year-over-year. The acquisition by Priceline is, in fact, bad news for Yelp. The acquisition is a perfect fit and will provide OpenTable with financial backing to compete directly against Yelp. As CNN Money recently reported:

"OpenTable is a great match for The Priceline Group. They provide us with a natural extension into restaurant marketing services and a wonderful and highly-valued booking experience for our global customers," said Priceline CEO Darren Huston.

"OpenTable will operate as an independent business led by its current management team within The Priceline Group, according to the companies."

Conclusion

On top of these negatives, Yelp has a massive short float of 21%. This further goes on to suggest that many investors don't have confidence in the stock. I think it is best for investors to avoid Yelp.


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