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Another look at why Yelp’s stock is too pricey

Yelp (YELP) has had a stellar run in the past four months, with its stock appreciating by more than 40%. This jump was driven by optimism around Yelp’s business model, as it continues to add more local businesses to its directory listing.

And while we agree Yelps’s business has tremendous potential going forward, we think the level of optimism currently surrounding the stock is overoptimistic. Yelp generates revenue through local advertising, display (or brand advertising) and other services like Yelp deals.

It competes primarily with other online business review services like Google (GOOG) Places, Yahoo (YHOO) Local, Angie’s List, CityLocal and Gumtree¬† — as well as display advertising players like Google, Yahoo, Facebook (FB) and AOL (AOL). It also competes with daily-deal sites like Groupon (GRPN) and LivingSocial.

We have a $16 Trefis price estimate for Yelp, which is significantly below its current market price. We have analyzed the reasons for our low estimate.


Local Advertising Business

The local ads business currently accounts for around 75% of Yelps’s stock value, and is its biggest revenue source. The local ad revenue for the company has tripled in the last two years, from $48 million in 2010 to $138 million in 2012. We have already accounted for local business growth in our valuation and project growth in local business accounts to 160,000 from the current 38,000 over our forecast period.

In the light of increasing competition from Angie’s List, Google, Yahoo and Facebook in local ads business, we think that capturing a higher base for Yelp will be difficult.

Average revenue per active local business is one of the most important drivers in our valuation for Yelp’s locals ads business. We expect this average for Yelp to decline from $2,860 in 2012 to $2,490 by the end of our forecast period (2019). The primary reason for this decline will be Yelp’s international expansion. As Yelp looks to expand into emerging economies, the average revenue will decline — because local businesses in these markets tend to spend less on ads compared to their counterparts in the U.S.

Yelp has also made inroads in Denmark, Finland and Norway, and we expect the lowered economic outlook in Europe to contribute to the decline in ad spending by businesses in the region.

Brand Advertising Division

Brand advertising is currently Yelp’s second largest source of revenue, and makes up 12% of its stock price estimate. Yelp competes with Google, Yahoo, Facebook and AOL for display ad revenue. Unique visitors are the primary driver for this division, and we project unique visitors per month to grow from 83 million in 2012 to over 250 million by the end of our forecast period.

The growing number of consumers searching for local businesses online constitute Yelp’s existing market, and the company’s global expansion plans will drive this growth in unique visitors on the Yelp site. However, the high level of competition will lead to lower average revenue per unique visitor, as advertisers can choose other well established Internet search engines such as Facebook, Google and Yahoo. We project a decline in average revenue per unique visitor from $20 in 2012 to $18 by the end of our forecast period.

Yelp Deals And Other Services

Yelp deals and other services is the smallest division of Yelp. The company has partnered with OpenTable to offer deals on reservation; however, Yelp only gets a small percentage from bookings done through its website. Moreover, the competition from specialized deal providers such as Groupon, LivingSocial, etc. is immense, and we project growth in this division will be limited. We expect revenue from this division to grow — from $7.5 million in 2012 to $15 million for our forecast period.

We currently have a $16 Trefis price estimate for Yelp, which is nearly 30% below its current market price.

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