Yelp

Yelp (YELP) is an interesting company that seems undervalued. This might stem from a misunderstanding about the core economic drivers of the business. While most consumers view it merely as a forum for restaurant reviews, this segment only accounts for 15% of ad revenue. Home & local services (i.e. plumbing, landscaping, contractors, doctors, etc) account for >50% of ad revenue.

Services revenue is primarily generated through an updated "Request-A-Quote" product, which prompts the user to solicit job quotes from vendors via a detailed questionnaire:

Yelp "Request-A-Quote" workflow. Source.

This likely generates much more highly qualified leads for advertisers than a generic, top-of-the funnel ad. Using a restaurant analogy, the difference would be a user who clicks on an ad for"Honolulu Restaurant" vs one who clicks on an ad for "Chinese restaurant open for lunch with availability for next Tuesday, located within 4 miles, and with a minimum rating of 4-stars". The latter user's intent is much more specific, or "qualified", which should result in higher conversions for advertisers, and sustainably higher ad rates for Yelp.

Services

Market Opportunity

While restaurants should continue to be a decent, but modest, growth opportunity for Yelp, the bulk of the growth opportunity is probably in home and local services. >80% of home service projects are still fulfilled offline¹ and the market is still highly fragmented. The user experience is miserable (how many times have you played phone-tag with a contractor to try to schedule an appointment, only to have them not show up?), with very little transparency - similar to the travel industry before Expedia, restaurant industry before OpenTable, real estate industry before Zillow or taxi industry before Uber. The value of a cleaner, more transparent online marketplace seems clear, and the business playbook is well-established.

Angie's List (ANGI) estimates the total addressable market (TAM) for home services at $500B, of which they have a <5% share ($20B) and <10% take-rate (resulting in $1.3B in 2019 revenue)². In other industries, like online travel and ride sharing, the larger players have closer to 15-20% share and 15-20% take rates.

Even if you assume that the TAM for home services is far less ($250B) than ANGI projects, that more limited online penetration reduces potential max share (10%), and that increased competition limits the take rate (10%), you're still left with a $2.5B revenue opportunity for each of the largest players.

ANGI earned $1.3B in revenue last year. YELP earned $973MM in ad revenue, of which 35% was from home & local services, implying $340MM of home & local services revenue. If you buy the back-of-the envelope economic argument above, and believe that Yelp can become one of the larger players in this space, there is the potential to grow this piece of the business 7x (340MM -> $2.5B). Even if the rest of the business didn't grow, this would result in 3x revenue growth overall ($1B in 2019 -> $3.1B)

Growth

Yelp's services revenue growth rate was only ~14% last year, and on the surface appears to be slowing, but "revenue attributable to Request-A-Quote increased nearly 60% in 2019 compared to 2018, and [they] significantly increased paid leads to advertisers in this category in 2019, which drove strong acquisition and retention among service provider customers."⁴ The pandemic will make 2020 comparisons noisy, but home services revenue actually increased YoY in Q2 2020⁵.

Furthermore, Yelp is only monetizing 10% of existing leads. It is unclear what percentage of these are for home services, but even in a stagnant market, it doesn't seem unreasonable to assume that there is much untapped growth potential here. The pandemic is also likely accelerating Yelp's shift to more aggressive monetization (home services is a segment that has shown more resilience while people are stuck at home).

Competition

The big question is whether or not Yelp can succeed in home services and capture significant share. Despite being significantly smaller than ANGI at the moment, I would argue that they are already winning, both in terms of providing a superior user experience and in terms of building a sustainable community and brand.

User Experience

The preferred ANGI workflow seems to be for the user to fill out a giant form and then blast the request to an unspecified list of service providers for quotes. This probably makes more money for ANGI (because they are generating more "leads"), but as a consumer I'd rather browse reviews first, and only request quotes from specific, pre-screened companies that match my preferences.

Using another restaurant example: if you're looking for a place for dinner, would you rather have your contact info sold to an anonymous group of restaurants, the quality of which you have no insight into, and await their "offers"? Or would you rather browse through a list of reviews, make your own judgments, and only contact the businesses that you are interested in?

Of course, this is entirely subjective, but the reader is encouraged to try requesting a home services quote on ANGI vs Yelp to compare the two experiences.

Community and Brand

While restaurants are not the primary revenue driver of Yelp, they are important for another key reason: user stickiness. A user may only need a plumber once a year, but they eat out multiple times per week. This gives users more opportunities to engage with Yelp, and Yelp will be top of mind when thinking about local reviews. This should result in both more reviews of local service providers, and in more "free" traffic for Yelp.

This is evident in search engine trends. According to SimilarWeb, 57% of traffic to HomeAdvisor (ANGI's largest brand) is from organic (free) search and 10% is paid. In contrast, 76% of traffic to Yelp is organic, and 0% is paid. Furthermore, >18% of Yelp's organic search traffic is "branded", in the sense that users are searching for "yelp" or "yelp.com", whereas only 5% of HomeAdvisor's organic search traffic is branded. A higher "branded search" share likely indicates stronger customer loyalty (because the user is looking specifically for results from yelp.com). The true Yelp branded search share is probably much higher when you consider that there is probably a huge "long tail" of searches where users search for "yelp" + "restaurant name."

Yelp's stickiness also shows up in its app usage numbers. According to AppAnnie, the Yelp iOS app has 740k total ratings vs only 27k for HomeAdvisor. Yelp is also a consistent top 100 app in terms of popularity, whereas HomeAdvisor rarely makes the top 1000. An average of 35MM unique users engage with the Yelp app per month vs 1MM with ANGI.

Odds & Ends

COVID

It may be surprising that I haven't spent more time talking about the pandemic, especially since small / local businesses, and restaurants in particular, are among the most heavily impacted. But the short answer here is that Yelp has plenty of cash ($525MM) on hand, generated positive free cash flow in both Q1 and Q2 despite unprecedented business closures, and feels confident enough about its financial position that it is bringing back furloughed employees and restoring salaries. If you believe that (eventually) things will return to normal, then they will likely be fine.

Google

A popular bear case against Yelp is that Google Local / reviews will continue to erode Yelp's influence. This is a key risk, as Google search traffic still accounts for a large percentage (76%) of Yelp's traffic. The risk is somewhat mitigated by an increasing share of users accessing Yelp's app directly and a decent proportion of "branded" searches, but it will continue to threaten Yelp long-term.

Google is also getting more sophisticated in terms of monopolizing service provider leads (they have a similar "Request-A-Quote" functionality, offer a guarantee on work performed, and perform background checks on businesses). Without government intervention, they will likely continue to leverage their search dominance to retain local services traffic and advertising dollars within their own ecosystem.

With that said, this is a headwind that Yelp has been facing for 15 years. I searched for a variety of businesses across a few key metros in the US, for both established and newly opened businesses, and Yelp often had just as many reviews as Google. In addition, Yelp reviews seemed consistently higher quality, more detailed, and more trustworthy. In general, Google reviews consisted of 1-2 sentences, often riddled with spelling errors, from users who had only a single review. While Google can force a broad swathe of users to use their ancillary products, they don't seem as focused on ensuring high quality content, and their record on building communities is mixed.

Private Market Value

Although I value Yelp on a DCF basis below, I think it's worthwhile to note that it would likely fetch more from a strategic acquirer, which in my mind sets a conservative floor on its asset value.

Yelp's current enterprise value (EV) is <$1B.

OpenTable was acquired by Booking.com for $2.6B in 2014 (and is still worth $1.1B after a $950MM impairment in 2016 and a ~$500MM impairment in 2020).

In 2009, Google was in talks to acquire Yelp for $500MM. This was when Yelp was 1/30th the size. Later on, Google bought Zagat, a much smaller player, for $150MM.

Porch has raised $120MM and is trying to go public at a valuation of $500MM despite losing $103MM in 2019, exhibiting "material weaknesses", and having 2% of the traffic levels of Yelp.

Thumbtack recently raised $423MM at a $1.6B valuation, but has recently had to lay people off and has 6% of the traffic of Yelp; for similar reasons as above, it's hard to see how they compete with Yelp's community long-term, even with help from Google.

ANGI's EV is $5.3B, 5x Yelp's despite having revenue of only 1.4x and similar profit margins.

Valuation

Although there are some more nuances, the investment case for Yelp is fairly straightforward:

  1. Even if you assume zero future growth from services, and zero recovery from COVID, Yelp seems fairly priced at current levels. On a private market basis, it seems undervalued.
  2. It seems probable that home service bookings will continue to shift and grow online.
  3. Yelp has many advantages (brand, community, review quality and user stickiness) compared to other players (ANGI, Thumbtack, Google).
  4. It seems plausible that Yelp can become a long-term player in home service provider reviews (and lead generation). They have already made significant inroads ($340MM in services revenue in 2019, 60% growth in "Request-A-Quote" revenue)

More concretely, my valuation assumes:

  • GAAP operating margin expansion from ~3.5% -> 12% over 10 years. There aren't a ton of comparables here, but in 2019: TWTR 10.6%; GOOGL 22%; ANGI 3%; NYT 10%; Y.TO 30%. Yelp also plans to expand their "adjusted EBITDA" margins by 10-15% by 2023, which, if adjusted to GAAP numbers, would put op margins in the 13-18% ballpark.
  • No recovery to 2019 revenue levels until 2024, due to COVID, resulting in a 0.70% 5-year CAGR and 2.83% 10-year CAGR. For reference, 85%+ companies of Yelp's size have historically grown faster, so these are exceedingly modest expectations.

This puts Yelp's estimated value per share at $29, 47% above its current price of $19.74. While Yelp is less hyped than some newer tech names, it seems like a decent, profitable business, in a growing industry, at an attractive valuation.

[PUBLIC 2020.10.14] YELP Valuation Model
Assumptions Automated WorksheetsRevenue WorksheetTTM,2019,2018,2017,2016,2015,2014,2013,2012,2011,2010,2009,2008,2007,2006,2005,2004,2003,2002Sales,$950,1014.194,942.773,850.847,716.063,549.711,377.536,232.988,137.567,83.285,47.731,25.808,$12,$0,$0,$0,$0,$0,$0YoY Growth,-6.31%,7.58%,10.80%,1...

Disclosure: I am long YELP.


¹ https://ir.angihomeservices.com/static-files/e76c46bd-6af6-4d58-bb7b-d12b5b0aee5b (Slide 5)

² ibid. (Slide 6)

³ For reference, in 2016, ~44% of travel bookings, 11% of retail purchases and 7% of restaurant bookings occurred online³; these numbers are probably much higher now, so merely 10% of home services shifting online seems like a conservative estimate (https://skift.com/2016/06/30/4-charts-showing-growth-of-online-and-mobile-travel-bookings-by-2020/)

⁴  https://www.bamsec.com/filing/134501620000009/1?cik=1345016&hl=39478:39726&hl_id=ey48qfplf

https://s24.q4cdn.com/521204325/files/doc_financials/2020/q2/Yelp-Q2-2020-Shareholder-Letter.pdf

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