Yelp Is Undervalued, but Is It a Bargain?

Online recommendation service provider Yelp Inc. (YELP) is among the few NASDAQ stocks that trade at a discount to their intrinsic value these days.

Last Friday, Yelp's shares closed at $32.53, roughly 15% below their GuruFocus Value line. The GF Value line is a unique intrinsic value estimate from GuruFocus based on three factors:

1. Historical multiples (PE Ratio, PS Ratio, PB Ratio, and Price-to-Free-Cash-Flow) that the stock has traded at.
2. GuruFocus adjustment factor based on the company's past returns and growth.
3. Future estimates of the business performance.

Meanwhile, Yelp has grown its revenue at an 11% three-year average annual revenue growth, which indicates that its business has been growing at a moderate pace for the internet content and information industry. The three-year Ebitda growth rate was even more robust at 31.6%. Ebitda is a measure of a company's operating performance and a proxy for cash flow.

Then there's the current operating margin, which stands at -3.5%, indicating that it is currently losing money from its operations. The operating margin is a measure of corporate profitability as a percentage of variable costs (wages and raw materials), before paying interest or tax.

Source: GuruFocus

The obvious reason for Yelp's low market valuation and negative current operating margin is the Covid-19 pandemic and its effects on the economy. That's why some financial experts believe the company's fortunes will change once the pandemic is over.

For instance, Barron's Eric J. Savitz expects Yelp's business to rebound once the pandemic is over, and therefore, gives the stock a positive review.

However, I don't think that's the case. In my view, Yelp's problems can be traced back to well before the Covid-19 pandemic, as evidenced by a history of erratic earnings reports. Positive earnings surprises have been followed by negative earnings surprises, taking the company's shares on a wild ride.

Then there's the history of negative economic profit for the company, as measured by the difference between the return on invested capital (ROIC) and the weighted average cost of capital (WACC), as shown in the chart above. It's a bad sign when the ROIC is lower than the WACC, as it indicates the company is losing value for shareholders. Economic profit is a measure of a company's competitive advantage and an indication of how effectively management deploys capital. A negative economic profit means that the company has no competitive advantage, and it is destroying value as it grows.

But Yelp's most worrying problem is how it monetizes its platform - particularly its reliance on reviewed companies rather than on consumers for its revenues.

That raises serious questions about its reviews' credibility among consumers. It also fuels tensions between Yelp and the reviewed companies over ad prices, as evidenced by complaints against Yelp filed with the Better Business Bureau.

Meanwhile, there's competition from upstarts like OpenLabel, which builds on Yelp's model, creating "consumer bar codes" for every product. These codes include broad information on the reviewed company and product brands, such as certifications, carbon footprint, political donations, worker treatment, health issues and safety records.

In short, Yelp is managing capital ineffectively and has a weak business model to monetize its platform, which could, perhaps, explain the low return of the stock over the past decade - a meager 1.49% average total return.

The bottom line is that, while the end of the Covid-19 pandemic could bring back the demand for online recommendations, it won't fix Yelp's ineffective capital management and business model. That's why I don't find its shares to be a bargain, even at the current price.

Disclosure: I have no position in Yelp.

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