The coronavirus pandemic unquestionably is a problem for Yelp (NYSE:YELP). Restaurant exposure alone presents a stumbling block to near-term growth. Investors have reacted accordingly: YELP stock has declined 26% so far this year.
Not that long ago, the news was much worse. Shares in fact touched an all-time low in March. They’ve nearly doubled since.
That rally admittedly makes some sense. Yelp closed its first quarter with nearly $7 per share in cash. In that context, a share price briefly below $13 probably was too cheap.
Even at $25, some investors might see an opportunity here. YELP stock seems like a classic recovery play. Simply getting back to February levels of $35 suggests a gain of roughly 45%. A return to growth in 2021 could drive even more upside.
But I’m not one of those investors. The case against YELP stock goes beyond the effects of the pandemic. Execution simply wasn’t that impressive heading into the year. Valuation is not particularly attractive. And there are real concerns about the business model.
Yelp simply needs to do better. And given the external environment, at best it’s going to take quite a while before that happens.
15 Months Later
In March 2019, Yelp released fourth-quarter earnings. Strong headline performance led to a brief afterhours rally, but YELP stock actually declined the following day.
That decline came despite the company releasing seemingly impressive multi-year targets for the operating business. Yelp said it planned to grow revenue at a “mid-teens” percentage rate for the next five years. Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) margins were expected to expand to 30% to 35% by 2023 from 19% in 2018.
As I wrote at the time, those targets suggested enormous upside. On the day of the release, YELP stock traded below $37. Hitting its goals suggested a share price in the range of $100.
But the reaction to that earnings report also showed a key problem: investors didn’t trust management or the targets. And as it turned out, they were right not to do so.
After all, in 2019, revenue rose just 7.6% year-over-year. EBITDA margins did improve, to 21%. But a 1.6-point expansion leaves the company behind pace for those targets as well.
Last year’s performance simply wasn’t good enough. It’s one thing to miss long-term targets, but to do so in year one is particularly disappointing. Nor did Yelp, before the pandemic, expect much improvement this year. The company’s original guidance for 2020 suggested 10% to 12% revenue growth, along with one to two points of incremental margin expansion.
How Yelp Is Driving Growth
To be fair, Yelp has grown its business at a decent clip over time, even if that growth has been slower than forecast on occasion. Adjusted EBITDA, for instance, grew at a 21% clip between 2016 and 2019. Revenue increased over 12% annually.
YELP stock priced in that growth, however. The stock was basically stuck from late 2015 through the beginning of this year.
I’m skeptical that this necessarily is going to change. For Yelp to truly take off, it needs to start driving “self-serve” revenue. That was true several years ago, and it’s still true now.
Yelp isn’t getting there, however. Rather, it continues to spend heavily on sales and marketing, which limits margin expansion. The 21% margins posted in 2019 are impressive but they benefit significantly from the exclusion of share-based compensation.
Stock issuance accounted for over half of the company’s adjusted EBITDA. Back that out, and the business simply isn’t that profitable, or that impressive. Nor is YELP stock all that cheap.
Business Model Concerns for YELP Stock
That story sounds somewhat like that of Groupon (NASDAQ:GRPN). Groupon too targets local businesses and has also struggled to control spending despite years of promises to do so.
Those similarities are why Yelp reportedly considered merging with the daily deal provider. But with GRPN stock too touching an all-time low this year, putting two bad businesses together wouldn’t make a good one.
Now, the pandemic adds a significant headwind to traffic. According to figures from Yelp’s Form 10-K filed with the U.S. Securities and Exchange Commission, restaurants account for 48% of user reviews. The category only drives 14% of revenue, but the traffic headwind may read across to other end markets like home and local services and beauty and fitness (both of which have their own short-term worries).
And with ad spending likely crimped, competition becomes a bigger issue. Facebook (NASDAQ:FB) and Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL) already dominate online advertising. It’s hard to see how Yelp can claw back market share in this environment.
There’s a worrisome combination of long-term execution worries and short-term disruption. And that combination suggests that even in a best-case scenario, YELP stock is a 2021 story. Of course, the problem for some time has been a “next year” kind of play. At some point, that needs to change.
Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets. He has no positions in any securities mentioned.
