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The Science of Hitting
The Science of Hitting
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Why I'm Close to Buying Yelp Again

Some thoughts on the company following second quarter results

May 12, 2019 | About:

Yelp (YELP) reported financial results for the first quarter of fiscal 2019 after the close on Thursday. Revenues increased 6% to $236 million, with a high-teens increase in ad clicks offset by an 8% decline in the average cost per click (CPC). Yelp has found success lately with its largest customers, with growth in the quarter driven by a 22% increase in revenues from national and multi-location advertisers. (As noted in the shareholder letter, “Advertising attribution tests we run on behalf of national advertisers consistently reveal the strong purchase intent of our audience and that Yelp ads are a top performer in driving consumers in-store.”) On the other hand, that math suggests that they’re currently struggling to grow their local (SMB) business. Time will tell if this is a short-term blip from the transition to non-term advertising or reflective of deeper issues (as an analyst at Keybanc put it last June, "“we are concerned that we’re already hearing a clear lack of commitment and indifference toward remaining on Yelp from recently added new customers, as well as pockets of already poorly perceived utility of the platform after only a few months").

User engagement on Yelp continues to grow, reaching 35 million app unique devices in the quarter (up 16% year-over-year), along with a 19% increase in cumulative reviews (to 184 million). Intent driven users attract businesses, with paying advertiser accounts up 8% year-over-year to 192,000. Active claimed businesses increased 16% to 4.5 million locations (for context, BIA Kelsey estimates there are over 20 million local business locations in the United States).

In Restaurants, Yelp’s most trafficked category, the company continues to see user activity move beyond the legacy directory and review product. New features include reservations through Yelp Reservations and Waitlist (with the number of seated diners up more than 40% sequentially) and online ordering through their partnership with Grubhub (the number of restaurants delivering through Yelp has roughly doubled over the past 18 months, with a record number of orders placed through the platform in March).

While the company is still largely known for restaurant reviews, that vertical accounts for less than 15% of its revenues. Over time, growth in Restaurants has propelled monetization across other categories by helping users discover and engage with other types of local businesses.

For example, sales in Home & Local Services (which accounts for one-third of Yelp’s revenues) grew at a low-teens rate in the quarter, fueled by offerings like Request A Quote (consumers can directly contact a service provider through the Yelp app before making a purchase decision). In the first quarter, Request A Quote volume increased 26% to more than two million submitted projects, with revenues up 50% year-over-year. Considering there’s roughly $40 billion in home services market spend in the United States every year, I continue to expect a long runway here.

The pace of growth in Yelp’s sales force has slowed, with headcount up 5% year-over-year (by comparison, it grew 15% in 2018). In addition, the company is shrinking their footprint and moving sales staff out of high cost regions like San Francisco, which should also help to reduce personnel costs. Sales & Marketing continues to be a significant line item for Yelp (53% of revenues in the quarter) and represents their largest opportunity to leverage operating expenses over time. That happened in the first quarter, with guidance suggesting Yelp should leverage sales & marketing expense for the full year as well (with help from mix shift to self-serve for SMB customers).

Sales and marketing expense leverage led to outsized growth in profitability: adjusted EBITDA increased 19% to $39 million, with EBITDA margins up roughly 200 basis points to 17%. (As a reminder, EBITDA margins expanded by nearly 700 basis points over the past five years.)

Yelp ended the year with more than $600 million in cash & equivalents and no long-term debt (roughly $7 per share of net cash). The company acted on their repurchase authorization, buying back $100 million of stock in the first quarter, as well as another $100 million between quarter end and the conference call; they remain on pace to repurchase $250 million of stock in the first half of the year. At period end, the company had 85 million diluted average shares outstanding.

Conclusion

Last time I wrote about Yelp, I laid out a few assumptions that led to $3.50 to $4.00 per share of earnings in 2023 (the key ones were low-double digit annualized revenue growth and 30% EBITDA margins). With a terminal multiple of 20 times trailing earnings and a 12% discount rate (as well as credit for the net cash on the books), that led to a fair value estimate around $50 per share. With the stock now trading around $33 per share, I think you can make a case that today's valuation is reasonable if you think Yelp can get close to the low end of management’s targets.

Following weak first quarter results and lackluster guidance, that seems questionable. Management has a lot of work to do in the back half of the year if they plan on hitting their 2019 financial targets (8-10% revenue growth and 200 to 300 basis points of margin expansion). Even then, meeting or exceeding long-term guidance will require even more heroics in 2020 and beyond.

Personally, I’m not particularly comfortable with that financial model (said differently, I don’t believe management’s long-term guidance is conservative). In addition, as CEO Jeremy Stoppelman noted on the call, Yelp is “still in the early days of a significant business transition.” The likelihood a of negative surprise in the coming quarters seems high here (of course, that may already be priced in).

If I change the key assumptions to a 9% revenue CAGR (comparable to what the company expects in 2019) and 28% EBITDA margins (500 basis points below the midpoint of long-term guidance), fair value declines to roughly $40 per share. While that’s a smaller margin of safety, I think you can make a decent case for Yelp at $33 per share. I have not bought the stock yet, but that could change.

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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