Yelp (YELP, Financial) has established itself as one of the most hated companies in the U.S. The company has fought several extortion claims over the past few years. Consistent reports exist of Yelp filtering only good reviews and displaying only bad reviews after the business concerned declines to advertise (due to the ridiculously high cost) with Yelp. It is safe to assume that Yelp has damaged many decent small and medium scale restaurants, which is why many business owners hate the company. There’s even a restaurant that offers a 50% discount to customers who leave them a bad review on Yelp.
However, being hated is not Yelp’s only problem. In my opinion, the company also has a terrible business model that looks unsustainable. Hence, I think investors should sell Yelp.
Burning cash
Having a bad image is never good for a company’s business, but that is the least of Yelp’s concerns. Yelp has been consistently reporting double-digit revenue growth, and it reported another 55% growth in the previous quarter. While this growth may seem impressive, the company’s operational expenses also grew over 50%. I have always doubted Yelp’s ability to record profits and the fact that it reported a loss of $0.02 per share despite spending a lot of money is alarming.
Besides, I also think Yelp’s M&A strategy is very weak. The company has spent money on acquisitions that will not prove to be beneficial in the long run. Earlier in February, the company acquired online food delivering startup Eat24 for $134 million. Eat24 has really thin margins as the acquisition hasn’t really added to Yelp’s bottom-line. Given the razor-thin margins, Yelp will find it difficult to compete against market leader GrubHub (GRUB) which has a profitable business model.
Yelp’s ROI has been terrible, and the company is burning cash at an unhealthy rate. So, I wouldn’t be surprised if Yelp delivers another miserable quarter and plunges further.
Fake reviews and rising competition
Yelp’s review filtering algorithm is pretty weak as bypassing it is fairly easy. Yelp's review filter is unable to detect a fake user if that user is moderately active. As a result, fake reviews are on the rise. Fake reviews have damaged the reputation of many good restaurants and aren’t good for Yelp’s business especially since the competition is increasing.
I have already discussed Google+ Reviews as Yelp’s competitor, but there are several other companies that can give Yelp a run for its money. Companies like Twizoo, and AroundMe app that have a profitable business structure and will act as a major roadblock to Yelp’s growth in the near future.
Twizoo uses people’s Tweets to accumulate data and recommends best places to eat or drink nearby. Twizoo was only launched in London, but the company is now entering San Francisco, New York, Washington, D.C., and Chicago. The company also offers free advertisements whereas Yelp demands $1,200 from restaurant owners. Yelp will find it difficult to compete against companies like Twizoo. Yelp is already struggling to report profits the increasing competition will further hurt its margins. Hence, I think Yelp is a good sell candidate.
Acquisition unlikely at present price
After Yelp’s terrible earnings report, the stock was trading at roughly $39, but it soon jumped 30% following a report suggesting that Yelp is looking for potential buyers. I don’t think any company would acquire Yelp at the present valuation. The company is trading at 72x trailing earnings and has a forward P/E of 71. This shows that the company’s earnings aren’t expected to grow significantly. Buying a non-profitable company that is burning cash wouldn’t make sense for anyone especially when there are other companies that have a profitable business model.
Conclusion
Summing up, I think Yelp’s business model is terrible. The company is burning cash at a rapid pace and has no profits to show for it. The company has a bad reputation among business owners and will continue to struggle due to increasing competition. Moreover, I think Yelp will find it difficult to find a potential buyer at the present valuation. I think investors should sell Yelp.
