Online review site Yelp (YELP) reported earnings Tuesday, and Yelp stock is off more than 8% in the aftermath. Part of the reason for Yelp stock’s plunge is the announcement of a secondary offering of $250 million. Yelp also posted a loss of $0.04 a share, well short of the consensus estimate of a profit of $0.01 a share.
But on the top line, Yelp showed strength. Revenues jumped 68% to $61.2 million, which beat the Street forecast of $59.5 million.
So the drop in the YELP stock price an opportunity here? To see, let’s take a look at the pros and cons:
Pros for YELP
Mobile: Yelp is positioned nicely for this fast-growing market. Keep in mind that local commerce is inherently mobile.
So yes, engagement has been high for YELP. In Q3, about 46% of local ads and 62% of searches were on mobile devices. The monthly average users is about 11.2 million.
A key part of YELP’s mobile strategy has been a strong relationship with Apple (AAPL). With this deal, Yelp has been deeply integrated into Apple maps, which has provided a strong source of traffic.
Market potential: It’s massive. According to IDC, there are 73 million local businesses across the globe. As for Yelp, it has only scratched the surface of the opportunity, with 57,200 local business accounts (the growth rate on a year-over-year basis was 61%).
In terms of expanding into other countries, Yelp has been getting more aggressive as well. This year Yelp entered markets like Brazil, the Czech Republic and Turkey.
Leverage the platform: With a growing user base, Yelp has an opportunity to expand its offering. One example of this is the purchase of SeatMe, which is a web/iPad-app based reservation system for restaurants. This cloud-based service could wind up being a nice revenue generator.
YELP also should benefit by expanding its service into new categories. For example, about 20% of reviewed businesses are restaurants but only 7% are arts & entertainment and 9% are in beauty and fitness.
Cons for YELP
Valuation: YELP stock trades at lofty levels, trading at a forward price-to-earnings ratio of 255X. (Keep in mind that prior to the YELP earnings report, YTD 2013 returns sat at a whopping 265%.)
The result is that YELP’s multiple is an outlier when compared to its peers. For example, OpenTable’s (OPEN) forward PE is 33X and Angie’s List’s (ANGI) is at 90X.
Competition: Yelp faces many tough rivals. Just some include Kudzu, Angie’s List, Urbanspoon, Foodspotting, Foursquare and OpenTable.
But perhaps YELP’s biggest threat is Google (GOOG), which continues to invest heavily in the local e-commerce space. The company also has huge advantages with its Android platform and hugely popular map app.
Yelp also gets over half of its web traffic from searches on Google. And this can certainly be dicey. As indicated in Yelp’s 10-Q:
“Google has removed links to our website from portions of its web search product and has promoted its own competing products, including Google’s local products, in its search results. Given the large volume of traffic to our website and the importance of the placement and display of results of a user’s search, similar actions in the future could have a substantial negative effect on our business and results of operations.”
Validity of reviews: Can Yelp’s reviews be trusted? This has always been a nagging question. Although, so far, it seems that users are willing to rely on them for making decisions.
But there have been some recent issues. For example, New York fined 19 businesses for fake reviews. Interestingly enough, Yelp has a filter that generally tags a quarter of the overall reviews as not authentic. But according to a study from the Harvard Business School, the system may actually be missing many more.
Verdict for YELP
In only nine years, YELP has built a strong brand in the local space. But the company has also invested in its sales infrastructure and product development. The result is that YELP has continued to be a top-notch player in the market and has been able to deal with tough rivals.
Despite all this, Wall Street has already factored in the much of the expectations for growth, as seen with its nosebleed multiple. In other words, if the competitive environment gets worse and Yelp’s growth path decelerates, YELP stock price could be vulnerable.
Given this, the cons outweigh the pros on the stock for now.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.