For the last few years, the performance from Yelp (NYSE:YELP) hasn’t been quite good enough. Yelp is growing: Adjusted EBITDA rose 16% in 2018, but growth was priced in. The YELP stock price is down 14% over the past year, and still sits below mid-2015 highs.
Yelp management clearly believes that will change. Executives laid out aggressive targets in conjunction with Q4 earnings last month. If Yelp hits those targets (or comes close) the stock has tremendous upside. But the initial reaction to those plans suggests that investors are skeptical. Recent history suggests they have good reason.
Yelp’s New Targets
In the fourth quarter release, Yelp detailed its targets for the next five years. Revenue is expected to rise in the “mid-teens” annually through 2023. Adjusted EBITDA margins are expected to rise 2-3 points in 2019 and at a similar pace for the following four years, ending at 30-35% against 2018’s 19%.
If Yelp hits those targets, earnings will soar. Assuming 15% annual top-line growth, revenue should double over the five years to $1.9 billion. Margins of 32.5%, the midpoint of the out-year target, suggest Adjusted EBITDA of $617 million.
That’s more than triple 2018’s $183 million. Assuming a 24% tax rate and a modest rise in depreciation and amortization, net income would reach the range of $400 million. That’s close to $5 per YELP share.
However an analyst runs these numbers, they suggest enormous upside. A 12x EBITDA multiple, plus cash, gets the stock to $100. A 20x P/E multiple – again, plus cash – gets YELP past that point.
The current YELP stock price sits below $37. As such, there’s a reasonable case that if Yelp management is right, YELP stock could triple. And the company is putting its money where its mouth is: the company doubled its share buyback authorization after Q4, and pledged to buy back $250 million of Yelp shares in the first half of the year alone.
The Reaction to Yelp Earnings
Of course, it’s also reasonably clear that investors don’t trust Yelp management. YELP stock actually soared in after-hours trading following the Q4 report. In regular trading the next day, however, the YELP stock price actually dipped modestly. An analyst upgrade gave the stock a boost, but it has weakened in recent sessions, and now trades well below its pre-earnings price.
That seems surprising given solid 2019 guidance, the long-term targets, and an impressive Q4. (Adjusted EPS of $0.37 crushed consensus estimates of $0.10.) But investors do have some reason to be skeptical.
Indeed, there are concerns with the Yelp business model, dating back to those I detailed on this site back in 2017. Yelp is projecting strong revenue growth but activity on the site isn’t increasing all that fast. Figures from the 10-K suggest that the number of reviews on Yelp has risen only 6-7% on average in the past three years.
The aggressive long-term targets are somewhat belied by recent performance. Revenue rose just 11% in 2018. Adjusted EBITDA margins were flat. Yelp is projecting quite an acceleration in the business, in terms of both the top line and margins.
Most of the operating leverage is supposed to come from sales and marketing, which Yelp believes can be leveraged by ten full points, the majority of the projected margin expansion.
That goal depends on one shift; one that Yelp hasn’t been able to master so far.
Self-Serve and YELP Stock
For Yelp to leverage sales and marketing spend, two things have to happen. First, revenue has to continue to grow. Secondly, Yelp has to drive that revenue growth while moderating its spending on sales and marketing.
That’s obviously easier said than done. That’s particularly true given that Yelp’s model requires intensive sales and marketing spend, which accounted for over half of 2018 revenue.
The way to do this is to drive a “self-serve” model. At the moment, Yelp is selling most of its services – which undercuts the value (and operating leverage) of the platform. It’s a model that looks a more like Groupon (NASDAQ:GRPN) than Match Group (NASDAQ:MTCH) or TripAdvisor (NASDAQ:TRIP). That’s obviously not a good thing.
So the pivot to more self-serve revenue makes some sense. The question is whether it will work. Yelp already is struggling with higher cancellations. And local advertising competition remains intense, with Facebook (NASDAQ:FB) an obvious rival and myriad other smaller and mid-sized offerings (including from newspapers).
The concern here is obvious. Yelp is having trouble keeping customers even while it spends 50%+ of sales attracting and maintaining those customers. Can it do better in terms of retention while spending less (on a relative basis)?
Investors don’t believe it can. Right now, that skepticism makes some sense. But if Yelp can show some progress and regain investor confidence YELP stock is too cheap. That’s a big ‘if’ – but it no doubt would lead to big rewards.
As of this writing, Vince Martin has no positions in any securities mentioned.
