Shares of recommendations site recently surged after it released its first quarter earnings, which suggested that the company was edging towards profitability. However, I believe that investors should avoid the temptation to chase this rally, since Yelp Inc (NYSE:YELP)’s business model still has major fundamental flaws.
I believe that despite Yelp’s recent success, there can only be two possible endgames for the San Francisco-based company — it will either get marginalized into obscurity by and, or it will be bought out by a larger company, such as.
In this article, I’ll explain the major threats to Yelp’s survival.
For its first quarter, Yelp Inc (NYSE:YELP)’s revenue rose 68% from the prior year quarter to $46.1 million. This was attributed to a 43% increase in monthly unique visitors to 102 million, which contributed to a 42% increase in total site reviews. Active businesses rose 63% year-on-year to approximately 45,000, while claimed local businesses increased by 58% to 1.1 million.
Despite this rapid growth in revenue, visitors, reviews and participating businesses, Yelp Inc (NYSE:YELP) failed to report a profit. However, its net loss of $4.8 million, or $0.08 per share, was much better than the $9.8 million loss it posted a year earlier.
During its conference call, Yelp stated that it intends to continue focusing on three main areas — mobile growth, international expansion, and local businesses.
Yelp Inc (NYSE:YELP)’s mobile app is now installed on roughly 10 million devices worldwide, which led to 36% of its total ads being displayed on mobile platforms, up from 25% during the fourth quarter; 30% of Yelp’s total monthly unique visits came from mobile devices. While that growth sounds impressive, Facebook Inc (NASDAQ:FB) recently announced that two-thirds of its 1.1 billion worldwide users are logging onto the site through their phones. That means Yelp has to accelerate its mobile growth more aggressively if it aspires to achieve Facebook-like mobile saturation.
Meanwhile, Yelp Inc (NYSE:YELP) introduced display ads in France and Spain during the first quarter. Yelp claims that Spain’s unique monthly visitors topped a million for the first time. It also recently announced that it had expanded into New Zealand. However, despite expanding into 21 countries, Yelp’s international revenue only contributed to 6% of its top line. This suggests that Yelp is getting ahead of itself in terms of global expansion, and a look at revenue versus expenses over the past two years confirms that.
Another company that got ahead of itself was Groupon Inc (NASDAQ:GRPN), which expanded into too many markets at once, without pausing to allow revenue growth to catch up to expenses. Both Yelp and Groupon Inc (NASDAQ:GRPN) follow the classic Internet growth model of prioritizing revenue growth ahead of profits.
Lastly, Yelp is working with local businesses to form ways to better measure the impact of Yelp reviews. During the quarter, Boston Consulting Group published a research report on Yelp’s impact on local businesses. The report claimed that local businesses see an average annual revenue boost of $8,000 by claiming a free Yelp business owner account. Moreover, a local business that buys advertising on Yelp, for an average of $4,000 per year, was found to gain an average of $23,000 in annual revenue.
While that sounds like a beefy return on investment for advertisers, some local businesses have called for a boycott of Yelp Inc (NYSE:YELP), due to the unreliability of its reviews. Critics claim that many businesses bribe customers or freelance writers to post favorable reviews, while Yelp allegedly suppresses unfavorable reviews of paid advertisers. Yelp has also been accused of extorting customers for paid advertising in exchange for the removal of negative reviews.
Therefore, Yelp still has a lot of unresolved issues that could still sink the company. Two major obstacles are already looming on the horizon: Facebook and Google Inc (NASDAQ:GOOG).