Don’t tell me we aren’t in a frothy market when another money-losing internet company like Yelp Inc (YELP) goes public and the bull market gets long in the tooth. Things like Yelp stock are going to fall badly and not recover. That is, unless some large company swoops in and pays a stupid buy-out price for it, which is not beyond the realm of comprehension.
For a business to be sustainable, it must solve a problem. Arguably, having a centralized place where people can review restaurants, bars, shopping locations, home and local services and so on, was a problem that needed solving.
However, one might say that this was a problem that needed to be solved, but it wasn’t an urgent problem. It was more like a mild inconvenience.
Other websites were sort of filling the gap. We had lived without this kind of service for a long time, although arguably Zagat was the go-to provider.
The problem with Zagat was that it got online way too late. It wasn’t comprehensive enough. It had a pay wall. Zagat forfeited the chance to become Yelp. So in a world of review sites, Yelp’s popularity has certainly risen to the top, if not close to it.
And it makes no money.
This is the perpetual problem for many online brand names. They make little to no money, or even show a loss year after year. Yet the market bids it up to insane levels.
Yelp stock had operating losses of $8.8 million in fiscal year 13, profit of $11 million in FY14 and operating losses of $21 million in FY15, with a net loss that year of $33 million. Yet the market values Yelp stock at $1.5 billion.
What message does this send to investors? It says that, even though Yelp is expected to continue to lose money, there is value in the platform and value in the visitors. Revenue was, in fact, $550 million last year, so that’s not chump change. Yelp stock also has very modest free cash flow of $26 million.
Yet there is nothing intrinsically special about YELP. Any other review site could take away its market share, offer a better user experience or any number of other things. If MySpace can blow up, so can YELP.
Two Endgames for Yelp Stock
Thus, if one is investing in Yelp stock, there are only really two endgames that are going to play out. The first is that nothing replaces YELP, it becomes the premier review destination for food, ad rates therefore increase and it eventually becomes profitable.
Although YELP is trying to diversify revenue streams, it still generates 82% of its revenue from advertising. So just like Facebook Inc (FB) and Alphabet Inc (GOOG, GOOGL), it is subject to economic cycles and a limited global advertising budget that doesn’t grow very much year-to-year.
Thus, I think that first endgame is very unlikely.
The more likely endgame for YELP is that it gets purchased. It’s an obvious choice for something like Tripadvisor Inc (TRIP), which does make money (about $200 million in FY15), is cash flow positive (also about $200 million), and has plenty of cash on hand (over $600 million). Other suitors might be Priceline Group Inc (PCLN) or Expedia Inc (EXPE).
That just leaves the question of price. Who knows? Priceline paid $2.6 billion for OpenTable, which I thought was stupid, and that was at a valuation of about 13x revenue. Does that mean YELP could go out at $7.15 billion, or $90 a share?
Not a chance … but could it go out at higher than its $20 trading price? Quite possibly.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.
