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The Science of Hitting
The Science of Hitting
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A Look at Yelp's 2018 Results

Some thoughts on the company following 4th-quarter results

February 18, 2019 | About:

Yelp (YELP) recently reported financial results for the last three months of fiscal 2018. For the quarter, revenues increased 11% to $244 million, with advertising revenues up 12%. Excluding the impact of Eat24, which was sold to Grubhub (GRUB) in October 2017, revenues for the year increased 18%. While the pace of revenue growth has slowed a bit, the long-term track record is still impressive: Over the past five years, Yelp’s revenues have more than quadrupled.

User engagement on Yelp continues to climb, with app unique devices up 14% to 33 million and cumulative reviews increasing 20% to 177 million. Users attract businesses, with paying advertiser accounts up 17% in the quarter to 191,000. Active claimed local businesses also increased by a high-teens percentage, to 4.3 million locations (to put that number in context, it’s estimated that there are more than 20 million local business locations in the United States).

In the Restaurant vertical, Yelp’s most-trafficked category, the company continues to invest to cement its leadership position as the go-to app for diners. This includes reservations through Yelp Reservations and Yelp Waitlist (with the number of seated diners up 200% in the fourth quarter) and online ordering through the company’s long-term partnership with Grubhub (orders on Yelp increased 27% in the fourth quarter). Despite competing offerings from companies like Alphabet (GOOG)(GOOGL), Yelp continues to add users and increase the value of its platform.

While the company is still largely known for restaurant reviews, that vertical accounts for less than 20% of the company’s advertising revenues. Over time, growth in Restaurants has propelled monetization across other categories by helping users discover and engage with local businesses. For example, revenues in the Home & Local Services vertical increased 29% in 2018. This growth was fueled by innovations like Request a Quote, where consumers can contact a service provider before making a purchase decision. In the fourth quarter, Request a Quote volume was up 41%, while run rate revenues attributable to the offering more than doubled to $38 million. There should be a long runway for growth in this business, with analysts at Goldman Sachs (GS) estimating there’s roughly $40 billion of home services marketing spend in the U.S. every year.

As discussed in recent quarters, the company has transitioned to non-term advertising that provides local businesses with more flexible choices and price points. This enables the company to offer its product to customers with periodic needs (the ability to start and stop ads), as well as small businesses that may not be willing or able to commit to minimum spending thresholds.

Yelp continues to aggressively invest in its sales force, with the number of advertising sales employees increasing nearly 30% from the year-ago period. This is a significant line item for Yelp (Sales & Marketing was 50% of revenues in 2018) and represents one of the company’s largest opportunities to leverage operating expenses in the coming years. That happened in 2018, with guidance suggesting Yelp will leverage S&M expense again in 2019 (the plan is to lean more heavily on self-serve products for the company’s small and medium business customers).

Adjusted EBITDA in the fourth quarter was $53 million, an increase of 27% (with margins up 300 basis points to 22%). EBITDA increased 16% in 2018 to $183 million, with margins flat at 19%. Over the past five years, Yelp’s EBITDA margins have expanded by roughly 700 basis points.

Yelp ended the year with $753 million in cash and equivalents. The board recently increased the repurchase authorization by $500 million, with the company stating its intention to repurchase $250 million of stock in the first half of 2019 (that’s equal to 7% - 8% of today’s market cap). There were 86.3 million outstanding shares at the end of the fourth quarter, down 3% from the year-ago period.

In 2019 (“a year of transition”), management expects high-single digit revenue growth, with EBITDA growing at a faster pace (200 to 300 basis points of margin expansion). Management also provided long-term financial guidance (2019 to 2023), including mid-teens revenue growth and significant EBITDA margin expansion (to the low-to-mid 30s, compared to 19% in 2018).

But considering the results the company has delivered as of late (and the lackluster 2019 guidance), that sounds aggressive. If you instead assume 12% annualized revenue growth, you get to 2023 revenues of $1.6 billion. At 30% EBITDA margins and with a few other assumptions, I get to net income of roughly $325 million and diluted earnings per share of $3.50 to $4.00.

With a terminal multiple of 20 times trailing earnings and an 11% discount rate (as well as credit for net cash on the balance sheet), I get to a fair value estimate of $50 per share. That’s a long way of saying that with the stock at $40 per share, you can still make a case that the valuation is reasonable if you think Yelp can get close to the low end of its targets.

In my investing, I need a pretty wide margin of safety to be comfortable with that fair value estimate (said differently, I don’t think those assumptions are conservative). I don’t plan on buying at today’s levels, but would consider investing in Yelp again if the stock fell back to the low-$30s.

Disclosure: None.

About the author:

The Science of Hitting
I'm a value investor with a long-term focus. My goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio - a handful of equities account for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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