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The Science of Hitting
The Science of Hitting
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Yelp: A Step Back in the Right Direction

A look at the company's 3rd-quarter financial results

November 10, 2020 | About:

Yelp (NYSE:YELP) recently reported results for the third quarter of fiscal 2020.

It was another difficult quarter, as expected, given widespread closures of many businesses around the United States, with revenues declining 16% year-over-year to $221 million. That said, it was a meaningful sequential improvement for Yelp, with revenues up 31% versus the result in the second quarter as the shelter in place orders and cautious sentiment throughout the country began to ease.

Much like on the top line, the company saw continued year-over-year declines in usage among end customers and advertisers, but with some meaningful sequential improvements: paying advertiser locations and app unique devices declined by 10% and 15%, respectively, from the year ago period, but were both up double digits compared to the second quarter.

The one metric that continues to buck the trend is cumulative reviews, which reached 220 million in the quarter (+10% year-over-year). As shown below, the number of reviews on Yelp has more than doubled over the past five years and is up more than 10x over the past decade (from 15 million).

The change in user activity has most notably been seen in Restaurants, Yelp's highest frequency category for page views and searches. While the category has seen a resurgence in recent weeks, with activity back to 80% of pre-pandemic levels, revenues have lagged. By my math, the Restaurants category has generated roughly $70 million in revenues for Yelp through the first nine months of the year – down by more than 30% from the first nine months of 2019. Thankfully, as I've noted in the past, the Restaurants category is not particularly important for Yelp from a financial perspective (it has accounted for 10% of the company's revenues to date in 2020).

Weakness in Restaurants has been offset by relative strength in the Home & Local Services category. Home & Local reported mid-single digit revenue growth in the quarter, with revenues of roughly $100 million – the first time any category has generated $100 million or more in revenues for Yelp in a quarter. This strength reflects heightened demand as a result of widespread lockdowns, as well as continued improvement in Yelp's ability to match demand (end users) with supply (local advertisers) through higher value offerings like Request-A-Quote. As management noted on the conference call, roughly 20% of Home & Local Services leads are now being monetized compared to less than 10% for the company as a whole in 2019. Moving down the income statement, adjusted EBITDA in the quarter was $53 million, down 10% from the year ago period. Margins increased by 200 basis points to 24% due to the company's continued focus on sales efficiency. As shown below, this level of margins is at the high end of what the company has reported in the past five-plus years.

A major part of the Yelp story has been a continued shift in the business towards self-serve ads and multi-location customers. These efforts have coincided with attempts to right-size the salesforce, as well as an opportunity to reduce headcount in high cost areas like San Francisco. While it's still early, I think there's reason to believe the business transformation is working: in the third quarter, compared to the mid-teens decline in revenues, Yelp's sales headcount was roughly 40% lower than it was in the year ago period. In addition, as noted on the conference call, management expects to maintain approximately the current size of their local salesforce for the foreseeable future. As those numbers suggest, the company is seeing meaningfully higher sales productivity as the business mix shifts to go-to-market channels like self-serve and multi-location, which lends itself to less sales and marketing spend (as a percentage of revenues):

In my opinion, this is the single most important metric to watch at Yelp over the coming years (the exception may be revenues, which hopefully returns to the 10%+ growth that the company was seeing early in 2020). This will determine whether the company can become a business with meaningful profitability. Despite the near term headwinds from the pandemic, Yelp continues to be in a position of financial strength. At quarter end, the company had $591 million in net cash on its balance sheet (roughly $8 per share). Given this, management noted on the call that they "believe it is appropriate to resume returning excess capital to shareholders." While I don't think we'll see much on this front in the final quarter of 2020, I do expect that we'll see a return to repurchases in 2021, barring any major setbacks in the continued reopening of the U.S. economy.

Conclusion

When I wrote about Yelp in August, I said the following:

"I continue to believe that Yelp is likely to be an attractive investment from current levels, but I say that with the caveat that we may face some difficult times in the months and quarters ahead… For now, I continue to be a shareholder."

The market responded positively to the third quarter results, with another strong run this morning as a result of the hopes around the Pfizer (PFE) Covid-19 vaccine news. As a result, Yelp now trades at roughly $29 per share – about 50% higher than where it traded at two or three weeks ago.

Honestly, the one thing I keep thinking about is that I made a big and costly mistake by not acting more aggressively when I was given the chance to do so earlier this year. Specifically, when I doubled my Yelp position in March, I should've been much more aggressive. It's hard to make this point without coming across as if I'm simply reacting to short-term price action that I would not and did not predict (Monday Morning Quarterbacking), but that's not what I'm trying to say. The point is that I've followed the company closely for years and had good reason to believe that it was quite attractive at $15 or $16 per share – but I still acted timidly. I've paid dearly (already) for doing so.

Next time around, hopefully I will not fumble such a great opportunity.

Disclosure: Long Yelp

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About the author:

The Science of Hitting
I desire to own high-quality businesses for the long-term. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with the top five positions accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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