Steadfast Is Excited About Yelp

Amidst all of the “the social bubble has popped” and “recent IPOs are down 50%” hoopla, Yelp Inc (NYSE:YELP) has quietly risen 13% since its IPO in March despite being unprofitable. Steadfast Capital Management, run by Robert Pitts, doesn’t think that’s been enough; the fund filed a 13G with the SEC disclosing that as of September 25th it had crossed the 5% ownership threshold and owned about 430,000 shares of Yelp (see stocks that Steadfast owned at the end of Q2 2012).

Yelp Inc (NYSE:YELP)

On a historical basis, Yelp’s revenue was up 67% in the second quarter of 2012 compared to the same period a year ago. However, expenses grew as well- sales and marketing expenses, the company’s largest costs, rose 65%- and losses actually grew from $1.2 million to $2.0 million. The first half of the year therefore showed net losses of $12 million versus $4 million in the first half of 2011. Thanks to the IPO, loss per share figures were better but that is something of a dubious distinction. In fact, Yelp Inc went (operating) cash flow negative in the first six months of this year- not a problem in liquidity terms, obviously, but technology companies are generally supposed to run in the opposite direction.

We’ve mentioned that Yelp Inc has negative earnings, and analyst consensus is for it to be slightly unprofitable for the rest of the year as well. However, the analysts expect a strong 2013 for the company: revenue is projected to increase 47% over the figure for this year, bringing Yelp to earnings of 6 cents per share. This figure still implies an incredibly high forward P/E multiple, but obviously the company would be expected to continue growing beyond that point. We’re skeptical of all of this as losses are growing and yet the stock still has a $1.7 billion market capitalization. At least Facebook Inc (NASDAQ:FB) is profitable!

The company believes that further investments in its product can drive growth, and increased headcount by 48% between June 2011 and June 2012. Yelp’s recent revenue growth has been driven by local advertising (which includes “profile pages” for businesses and localized ads displayed on the site), and there does seem to be progress in growth on that front when looking at operating statistics. “Active local business accounts”, a key metric, increased to 32,000 from 15,000 a year ago (though note that the company is taking in less revenue per account). Monthly unique visitors were up 52% over the same period, about even with the revenue growth the company experienced.

We think the two closest peers for Yelp are Groupon Inc (NASDAQ:GRPN), which also focuses on local advertising (albeit through email marketing rather than providing an on-demand search site) and OpenTable Inc (NASDAQ:OPEN) (which allows users to make reservations at local restaurants). Groupon has very low earnings on a trailing basis, but the sell-side expects 36 cents of earnings per share next year which would yield a forward multiple of 13. That is considerably more reasonable than where Yelp is trading, and Groupon is growing its revenue well (up 45% in Q2 versus the same period in 2011). Groupon deserved a steep price decline following its IPO, but could actually be a better value than Yelp at this point. OpenTable is solidly in the black, but its growth rate- while high- is not at the same level. It trades at 48 times trailing earnings and 23 times forward earnings estimates, based on a 15% revenue growth and an actual decline in earnings in its most recent quarter compared to a year earlier. We wouldn’t buy it right now.

We would also compare Yelp to Facebook and Google Inc (NASDAQ:GOOG). Facebook, like Groupon, was certainly overpriced when it IPOd and at 36 times forward earnings estimates we think it’s still too expensive now (read more about Facebook’s valuation). Revenue has been growing, but the company faces concerns as to whether its advertising offerings are actually effective. Compared to these previous four companies, Google is a breath of fresh air (read our analysis of Google and other tech companies). It carries a forward P/E multiple of 15- below that of all of these companies except for the barely profitable Groupon- and combines a solid growth rate in its financials with substantial historical earnings (the trailing P/E is 22). It also has a strong brand name, a good competitive position in a variety of growing (and already lucrative) markets, and a large amount of cash on its balance sheet. Yelp has good potential, but we would prefer Google as an investment until the company starts showing that its expansion plans can generate positive earnings.

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