Yelp Inc. (NYSE:YELP) – Investment Memo – 6/14/16

Article Title: “Buy Yelp: The Network Effect is Strong with this One”

Recommendation: Yelp Inc. (NYSE:YELP) equity

Current Stock Price: $26.83

Target Stock Price: $50.00 (86% return)

Timing: 2 years

Catalyst: improved monetization of Yelp platform, potential sale of company

Summary Thesis

Yelp is the number one online business directory and local business recommendation

service with over 140 million monthly active users and over 100 million crowd-sourced

business reviews

Yelp’s platform would be extremely difficult to re-create due its vast collection of user

content reinforced by a network effect. This provides a deep competitive moat

Compared to network effect peers, Yelp’s platform is dramatically under-monetized.

Management’s current effort to monetize the platform will catalyze the market to re-rate

the stock higher

On a relative EV/Revenue basis, Yelp appears to be as much as 50% - 100% under-

valued. A bottom-up analysis to estimate intrinsic value yields similar results

There is likely limited downside due to Yelp’s attractiveness as an acquisition target if

the market does not reflect Yelp’s strategic value

The Yelp Platform and its Network Effect

Yelp was founded in 2004 by ‘Paypal Mafia’ members Jeremy Stoppelman and Russel

Simmons. Stoppelman, who was a Harvard Business MBA student at the time, dropped out of

school to pursue Yelp full time. The company was a venture darling, receiving numerous funding

rounds at rich valuations before IPOing in 2012. Today, Yelp is the number one online business

directory and local business recommendation service with over 140 million monthly active users

and over 100 million crowd-sourced business reviews.

Yelp can be thought of as a kind of social network for local businesses where consumers can

discover new businesses, provide reviews/recommendations, communicate directly with

businesses, make reservations, and make purchases.

From the consumer’s perspective, Yelp is an invaluable tool because it is the most

comprehensive and consistent local business directory. When looking up a business, Yelp

provides the most up-to-date business profiles and includes a map, store hours, contact

information, photos, and most importantly customer reviews. Yelp consistently has more user-

Capitalization Financials Valuation

Market Cap $2,037 2015 Sales $550 EV / 2015 Sales 3.0x

Cash & Equivalents $384 2016 Growth 27.0% EV / 2016 Sales 2.4x

Debt $0 2015 EBIT ($21) EV / 2016 EBITDA 16.7x

Enterprise Value $1,653 2015 Margin (3.8%) Price / 2016 EPS 39.5x

Note: based on market data and analyst consensus estimates as of 6/13/16.

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generated content on each page than direct competitors. For example, I searched for half a dozen

small businesses in my neighborhood and on average competitor ‘Google Places’ had roughly

1/5 the number of customer reviews when compared to Yelp. In total, Yelp has over 100 million

crowd-sourced reviews which have been contributed to the platform over the last 12 years.

The scale and depth of the local business content makes Yelp a unique asset that would be

extremely difficult and time consuming to replicate, providing the company a sustainable

competitive moat.

From the business owner’s perspective, Yelp is an invaluable tool because Yelp profiles are an

online store front which facilitate the online discussion with customers and shape the first

impression many customers have of a business. Business owners use Yelp because that’s where

its customers are and if managed effectively Yelp is an effective lead-generator. An independent

Harvard academic study found that a “one-star increase in Yelp rating leads to a 5-9% increase in

revenue…[and] this effect is driven by independent restaurants.”

http://www.hbs.edu/faculty/Pages/item.aspx?num=41233

This self-reinforcing cycle where the Yelp platform is valuable to consumers and businesses

because each party is contributing to the platform is a great example of the Network Effect.

Specifically, Yelp is a two-sided network because it brings together businesses and customers in

a self-reinforcing social marketplace. The network’s intangible value is driven by having a large

audience and maximizing engagement. Once a network has reached critical mass and

everyone is hooked, the switching costs to using other platforms becomes insurmountable.

Yelp’s management team has been very careful to nurture the network effect as it is the key

driver of value for the business. Yelp’s strategy to build and enhance the network is to focus on

growing local communities, encourage engagement, and to never compromise the user

experience.

To initially build local communities, Yelp hired local representatives to employ word-of-mouth

advertising, add content, and host events. Once a community matures and the network effect

begins to take hold, usage grows exponentially. One key reason Yelp has been successful is that

it has enjoyed a first-mover advantage in most regions.

To encourage engagement, Yelp has made its platform extremely easy to use and available on as

many platforms as possible. The company prides itself on being one of the first apps in the

iPhone app store; more recently, Yelp has been made available on smart watches and has been

integrated into search engine results and the Apple Maps app. Yelp is always trying to find ways

to improve engagement because empirical evidence has shown that the more engagement on the

platform, the more likely users are to repeat usage and the better the platform can be monetized.

Poor engagement is what led to the demise of social networks such as Friendster and MySpace.

Lastly, Yelp’s focus on the user experience drives engagement and keeps the platform ahead of

competition. Part of improving the user experience is constantly testing enhancements to existing

features such as adding content to profiles or improving the recommendation algorithm. In recent

years, Yelp has rolled out several new features which facilitate transactions between users and

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businesses. In 2013, Yelp acquired SeatMe which enables customers to make reservations

directly on yelp. In 2015, Yelp acquired Eat24 which enables customers to order food for deliver

or pick-up. Yelp also has features which allow customers to communicate directly with business

owners, solicit price quotes for services, participate in deals (similar to Groupon), and more.

Yelp is also willing to sacrifice short-term economic gain to maintain the quality of the user

experience. In 2015, Yelp shut down its brand advertising products which accounted for over

$30 million in revenue. Brand advertising was in the form of display and video advertisements

which disrupted the user experience and increased data usage and page load times.

Today, Yelp has 145 million monthly active web users, making it by far the largest platform

focused on local business reviews and recommendations in North America. By comparison,

Angie’s list (Yelp’s direct competitor) only has 3.3 million active users despite the company

being 9 years older. Yelp also is a share leader in local business smart phone apps with over 30%

penetration.

Yelp's Network Effect Metrics

2008 2009 2010 2011 2012 2013 2014 2015 LTM

Desktop Unique Users 53,946 62,336 77,713 77,628 74,607 77,433

Mobile Unique Users 11,850 23,972 42,292 57,770 65,860 68,551

Total Unique Web Users 15,736 26,077 39,356 65,796 86,308 120,005 135,398 140,467 145,984

Growth % 65.7% 50.9% 67.2% 31.2% 39.0% 12.8% 3.7% 4.2%

App Unique Users 5,654 9,178 10,613 14,541 20,006 21,186

Growth % 62.3% 15.6% 37.0% 37.6% 39.1%

Cumulative Yelp Reviews 4,689 8,834 15,115 24,817 35,959 52,757 71,232 95,210 101,564

Growth % 88.4% 71.1% 64.2% 44.9% 46.7% 35.0% 33.7% 33.6%

Claimed Local Businesses 25 120 307 606 994 1,488 2,029 2,648 2,834

Growth % 380.0% 155.8% 97.4% 64.0% 49.7% 36.4% 30.5% 31.5%

Note: Units in thousands. Unique users defined as the average monthly active web/app users in the last 3 months of the period. Claimed Local Businesses defined

as the cumulative number of businesses where a representative of a business location has claimed a Yelp listing page.

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However, user growth has decelerated since 2014. This deceleration in user growth has

coincided with the collapse of Yelp’s share price and valuation. The law of large numbers

dictates that a platform as large as Yelp cannot grow its user base at high double digit rates

forever and Yelp is likely approaching a mature level of active users in North America. Given

that smart phone penetration for Yelp is only 30%, there is still room for growth.

Management has responded by initiating a national TV advertising campaign and has disclosed a

$50 million advertising budget for 2016 on top of $30 million spent in 2015. Management has

cited that despite the size of Yelp’s platform, the brand’s unaided awareness was only 26%

before the start of the TV campaign. After the 2015 campaign, unaided brand awareness

improved to 41%. The company believes that investing in its brand will improve the Yelp

platform’s relevancy and user interest.

Despite the deceleration in user growth, engagement growth has been extremely strong. The

amount of reviews and listed businesses has continued to grow in excess of 30% despite low

double digit user growth. Engagement is what counts because it’s what makes the network effect

sustainable and is what will generate the best advertising ROI. Strong engagement also makes it

more likely that users will use the platform for transactions such as ordering delivery or making

reservations.

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Mobile app user growth has been strong which is also encouraging because Yelp’s mobile app

users are on average 10x more engaged than website users and are more likely to repeat

usage. The boon in mobile app usage is also a boon to Yelp because of the relevancy of

geolocation and how that can translate to more targeted ads.

CFO Lanny Baker commenting on the Yelp’s transition to mobile (5/26/16):

“Yelp is like fundamentally better on a phone than it is on a desktop. You -- the ability to take a

picture on your desktop almost doesn't exist. The relevance of maps and of directions and open

office hours and all these kind of things are so much more pertinent on the mobile experience. So

I think just the sort of secular trend toward mobile is a huge sort of favorable environmental

change for the Yelp business and that we're getting a platform that just allows both, makes it

easier to contribute and it makes it easier to get value back from those contributions”

Monetizing the Network

The value of Yelp’s platform as it relates to the strength of its network is enormous; however, the

network value is intangible until it is monetized. As it stands today, Yelps platform is extremely

under-monetized relative to peer network effect companies. This observation is especially

obvious when considering how close Yelp’s platform is to customers making financial decisions.

The truth is that management has (rightly) prioritized building an indispensable platform and

reinforcing its network effect. However, now that Yelp’s platform growth is approaching mature

levels of adoption, the focus should shift towards monetization. Management has started to focus

on monetization which is evidenced by the massive ramp in the sales force and the roll out of

transaction-oriented features.

In studying the universe of network effect companies, there are a few paths to monetization:

built-in advertising, charging customers to use the platform, charging businesses to use the

platform, charging for transactions facilitated within the platform, and charging for access to

platform-generated data. Of the menu of options, Yelp is currently running ads, charging for

transactions facilitated, and offers a (very limited) premium profile service for businesses. I

believe Yelp will be able to extract significantly more value from these existing monetization

programs. However, I believe Yelp should also consider charging all businesses a basic fee for

using the platforms – direct competitors Angie’s List and Trip Adviser currently do this.

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The above table summarizes a few salient points regarding monetization of network effect

companies:

1) Networks that are close to financial decision have more avenues for generating revenue.

For example, LinkedIn has a pulse on the job market and primarily monetizes to

companies making hiring decisions. Yelp is pivotal in purchase decisions regarding local

businesses.

2) Business review and recommendation companies Angie’s List and TripAdvisor are able

to generate 20% - 25% of their revenue by putting up a paywall. Yelp can put a paywall

for local business owners that wish to engage directly with customers and use Yelp’s

business analytics tools which are currently given away for free.

3) Transactions can be a major or primary driver of monetization. Yelp is moving in the

right direction with its transactions roll out and should continue building its brand here.

Improving Advertising Monetization

Advertising is currently Yelp’s largest monetization tool. Yelp’s advertising sales / monthly

active web users is $3.52 in the last twelve months period - this calculation conservatively

excludes mobile app users to avoid double counting. On a relative basis, Yelp’s ad rate of $3.52

Monetization of Network Effect Companies

Company Monetization Mix Monthly Active Users Monetization Rate Employees Notes

FacebookAdvertising (95%)

Payments (5%)

Global 1,591m

US & Canada 219m

Global $3.54

US & Canada $12.8412,691

FB is not close to financial decisions. Monetization is driven by

traditional advertising.

LinkedIn

Job Placement (63%)

Advertising (19%)

User Subscription (18%)

Corp. Accounts 43k

Global 105m

Corp. Accts $43.67k

Ads $5.54

Subscriptions $5.07

9,372Job placement monetization is the lion share; however, $10/ user

monetization (ex-jobs) is still above peer average.

TripAdvisor

Advertising (75%)

Subscriptions &

Transactions (25%)

Global 350mAds $3.19

Total $4.263,008

~50% sales generated internationally. Recently introduced transaction

features to book travel. Monetization rate expected to improve.

TwitterAdvertising (90%)

Data Leasing (10%)

Global 320m

US 65m

Global $6.93

US $22.203,898

Still in early stages on monetization. 2015 saw 58% revenue growth.

Advertising strategy focused on national brands.

Zillow GroupRE Professionals (86%)

Display Ads (14%)

RE Pros 92k

Users 124m

RE Pros $6k

Total $5.212,204

Monetization focused on professional accounts. RE Pro revenue

consists of ads and subscriptions. Still growing at a high rate.

GrubHub Food Delivery (100%) Active Diners 6.7mTotal ARPU $53.64

Average meal $28.391,105

Purely transaction-based model but reviews and recommendations

are still an important aspect to the platform.

Angie's ListBusinesses (80%)

Subscriptions (20%)

Subscribers 3.3m

(MAU not reported)

Business Ads $83.74

Subscriptions $20.621,730

Angie's is a direct competitor to Yelp in local business reviews but

has taken a monetization-first approach with a paywall.

YelpAdvertising (91%)

Transactions (9%)

Website 146m

Phone Apps 21m

Ads $3.52

Transactions $0.354,028

Monetization is low relative to other platforms despite being much

closer to purchase decisions. Sales force is relatively larger.

Yelp's Advertising Revenue Monetization

2009 2010 2011 2012 2013 2014 2015 LTM

Unique Web Users 26.1 39.4 65.8 86.3 120.0 135.4 140.5 146.0

Growth % 65.7% 50.9% 67.2% 31.2% 39.0% 12.8% 3.7% 2.5%

Advertising Revenue (1) $20.4 $35.7 $65.6 $117.0 $201.1 $337.8 $474.8 $513.7

Growth % 74.8% 83.8% 78.3% 71.9% 67.9% 40.6% 36.8%

Ad Sales / User $0.78 $0.91 $1.00 $1.36 $1.68 $2.49 $3.38 $3.52

Growth % 15.8% 10.0% 36.0% 23.7% 48.8% 35.5% 33.5%

Sales Force Headcount 750 1,100 1,547 2,220 2,300

Growth % 46.7% 40.6% 43.5% 31.4%

Sales Force Productivity (2) $183,423 $211,807 $244,044 $247,618 $256,442

(1) Excludes brand revenue.

(2) Total revenue / sales force headcount.

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per active user is far below the average peer rate of $9.80 in the US; Yelp’s revenue is

virtually all US-based. Even when removing the high and low outliers (Twitter and

TripAdvisor), the peer average is $7.86. Yelp’s ad rate is growing at ~30% per year. If this ad

rate growth is maintained, Yelp will hit monetization levels of ~$6/user by 2017 and ~$7.5/user

by 2018, bringing it more in line with peers.

Yelp will hit improved ad rates through continuous improvement of its product and marketing

investments (sales force and brand advertising). Yelp is constantly investing in its ad products to

improve performance. For example on the Q1 2016 earnings call, the company indicated that an

improvement to its algorithm led to a 10% uplift in ad delivery. At the end of 2014, Yelp moved

to only selling performance-based advertising (cost per click). Performance based advertising

will lead to improved advertising ROI and subsequently higher ad rates. Yelp estimates that the

move toward performance based advertising has improved ad ROI on average of 269%. Finally

Yelp has developed a suite of analytical tools which provide better information to advertisers and

help track and justify Ad ROI.

The company is also investing in growing its sales force to spur growth. Sales force headcount is

expected to grow ~25% in 2016. Yelp’s local advertising model requires more sales people than

peers because local business is much more reliant on offline channels for advertising and

promotion. Yelp has found that it needs to educate its customers and raise awareness of its

products. Over time less sales people will be needed and a greater portion of advertising

sales will be on a self-serve basis (like Google). Typically a local business will strike its first

one year contract with a sales person but will return on their own volition and utilize the self-

serve advertising tools. Currently ~30% of Yelp’s ad sales are completed on a self-serve basis.

As the volume of self-serve ad sales rises, Yelp’s profit margins will incrementally improve.

These observations have been confirmed by conversations I have had with Yelp sales people and

small businesses utilizing the platform.

Improving Transactions Monetization

Outside of advertising, customer to business transactions represent the largest monetization

opportunity. Given Yelp’s incredibly advantageous position as the gateway for local business

discovery, it is a natural step for Yelp to make it easier for customers to purchase goods or make

reservations directly on the platform. Enabling transactions is also beneficial because it drives

user traffic, improves engagement, and makes the platform stickier for both consumers and local

US Ad Monetization / MAU

Facebook $12.84

LinkedIn $5.54

TripAdvisor $3.19

Twitter $22.20

Zillow Group $5.21

Average $9.80

Average Ex High & Low $7.86

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businesses. Finally, facilitating transactions makes a great deal of financial sense because these

features can be bolted onto the existing platform and generate high incremental margins.

The largest transaction opportunity for Yelp is in online food ordering and delivery. In 2015, the

company acquired Eat24 to bring this technology in-house. Before the acquisition, Yelp

partnered with Eat24 and became familiar with the economics of the business; however, Yelp

wanted to own the platform in order to better integrate its capabilities within the overall platform.

Online food ordering is a competitive market but as the leader in restaurant recommendations,

Yelp has a clear advantage in cheaply acquiring customers. The biggest competitor is GrubHub

Seamless which has 6.7m active users on its platform that generate $50 of fee revenue per

customer per year. Despite the fact that GRUB is growing at a 30%+ rate, the company is highly

profitable with EBIT margins in the high teens. Eat24 currently operates at break-even EBITDA,

however, as the platform scales up (it’s currently ~20% the size of GRUB) it should generate

strong consistent returns. If just 2% of active Yelpers use Eat24, then the company’s food

ordering business will have half the customers of GrubHub Seamless; if 5% of Yelpers user

Eat24 then it will surpass GrubHub Seamless.

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Yelp also offers a few other transaction features including a restaurant reservation platform, a

deals businesses (similar to Groupon), and a service which allows customers to solicit price

quotes for local services. There are countless possibilities for ways to facilitate transactions. For

example, Yelp could partner with other companies to allow customers to reserve hotels (like Trip

advisor), allow local businesses to post job openings (like LinkedIn), facilitate a local business

services market place (like TaskRabit or craigslist), ect.

TripAdvisor is a good case study of a social network introducing ways to monetize from

transactions. TripAdvisor is a social network for people to plan vacations and share

recommendations for travel packages, hotels, restaurants, and adventures. Historically TRIP has

made money by charging hotel and tourism companies for subscriptions to use the platform and

advertise. In 2014, TRIP rolled out its Instant Booking product which allows customers to book

reservations directly through the website. Instant Booking has been positively received because it

improves the customer experience by conveniently eliminating the step of going to an online

travel agency website to make reservations. As a result, TRIP was able to triple its non-

advertising revenue in 2 years and create substantial value for the business.

Like TRIP, Yelp is well positioned to close the transaction loop because customers naturally go

to Yelp first in order to read the reviews before calling in a reservation or going to another

website to make a reservation.

Potential Subscription Revenue from Business Owners

Lastly, I believe Yelp could introduce a nominal fee to local businesses for the ability to use

Yelp to communicate directly with customers or to access the many analytics tools which Yelp

currently gives away for free. Yelp could also introduce additional tools such as a CRM platform

to generate subscription fees from the millions of small businesses which use Yelp as a critical

communication and marketing platform.

Businesses need to use Yelp because their customers and potential customers are using it and the

platform has a pronounced influence on driving sales. Therefore, local businesses want to be on

the platform to monitor customer activity, respond to questions, address feedback, and help

shape the conversation. Given Yelp’s importance, it seems like Yelp is missing a huge

opportunity to charge businesses either for basic access or at the very least offer some of its

features in a premium subscription package. It is worth noting that virtually all of Yelp’s peers

charge business accounts for the privilege of managing their own sponsored account.

For example, Yelp could introduce a premium subscription product for $10 / month which

provides the ability to communicate with customers and access detailed analytics. There are

currently 2.8 million claimed local businesses on the Yelp platform. If 25%, or 700k, of these

already registered businesses opted to pay the $120 per year, Yelp would generate an additional

$84 million in revenue at a very high incremental margin because these features already exist.

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Valuing Yelp

Because Yelp and most of its peers are not yet profitable, valuation is much more of an art than a

science. If you buy into the argument that Yelp’s platform is a unique internet asset which has

many potential levers of profitable monetization, then Yelp is highly valuable to investor who

will one day be rewarded once the platform is mature.

On a relative basis, Yelp looks cheap on an EV/Revenue basis. When excluding Facebook

(which has the highest multiple), the median EV/Revenue is 4.9x which implies that Yelp is

trading at a 45% discount to peers.

When Yelp is viewed through the lens of EV/Active Monthly Users, Yelp appears extremely

undervalued because it is trading for less than half the implied customer value of the next lowest

peer. Given the discussion earlier about the potential for Yelp to easily double its advertising

monetization rate and potentially generate hundreds of millions in sales from transactions and

subscriptions, Yelp deserves a higher valuation than the market currently implies.

The best way I could think of to estimate the potential intrinsic value of Yelp is to build a

bottoms-up model of what Yelp’s earnings potential would be at a normalized level of

monetization and operating margins. In the below chart, I estimated the value for Yelp’s

advertising business, food delivery business, and untapped potential of an earnings stream from a

premium subscription fee charged to business users. I believe this method is also consistent with

how strategic acquirers with better ability to monetize Yelp’s platform would think about value.

Relative Trading Value Analysis

Enterprise Market EV / Revenue Price / Earnings LTM FCF NTM Sales '16 EBIT Monthly Sales / Act. EV / Active

Company Name Ticker Value Cap LTM NTM LTM NTM Yield % Growth % Margin % Act. Users User (1) Users (1)

Facebook FB $305,311 $325,932 15.4x 10.9x 69.9x 28.9x 2.1% 41.5% 54.5% 1,591 $12.4 $192

LinkedIn LNKD $23,696 $25,690 7.4x 6.1x N/A 52.2x 1.2% 20.8% (3.1%) 105 $30.6 $226

TripAdvisor TRIP $9,052 $9,633 6.1x 5.6x 59.5x 34.5x 3.2% 9.3% 17.2% 350 $4.2 $26

Twitter TWTR $8,161 $10,135 3.4x 2.9x N/A 26.0x 1.1% 18.8% (12.0%) 320 $7.4 $26

Zillow Group ZG $5,556 $5,840 7.9x 6.4x N/A N/A (0.3%) 23.7% (7.9%) 124 $5.7 $45

GrubHub GRUB $2,069 $2,393 5.4x 4.1x 63.9x 34.0x 1.1% 30.2% 15.7% N/A $57.2 $307

Angie's List ANGI $468 $470 1.4x 1.3x N/A 26.5x 1.2% 2.6% 2.4% N/A $104.4 $142

Mean $50,616 $54,299 6.7x 5.3x 64.4x 33.7x 1.4% 21.0% 9.5% 498 $31.7 $138

Median $8,161 $9,633 6.1x 5.6x 63.9x 31.4x 1.2% 20.8% 2.4% 320 $12.4 $142

Yelp YELP $1,662 $2,037 2.8x 2.2x N/A 35.7x 1.4% 25.4% (2.2%) 146 $4.0 $11

Source: Capital IQ, Wall Street consensus estimates. Data as of 6/13/2016.

(1) GrubHub's active user metric is annual active diners. Angie's List's active user metric is total paid members.

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Illustrative Yelp Valuation at Normalized Monetization Levels

2016 2017 2018 Notes

Customer Base (MM)

Advertiser Audience 147.5 150.4 153.4 Unique web visitors at 5% growth

Food Delivery Users 1.5 3.0 4.6 1%, 2%, and 3% of unique users

Subscriptions 0.7 0.8 1.0 25% of local claimed businesses

Monetization rate

Advertising Rate $4.45 $5.79 $7.53 Assumes 30% annual ad rate growth

Food Delivery $50.00 $50.00 $50.00 Consistent with GRUB

Subscription Fee $120.00 $120.00 $120.00 $10 / month business subscription

Revenue Generated

Advertising $657 $871 $1,155

Food Delivery $74 $150 $230

Subscriptions $79 $95 $114

Total Revenue $810 $1,117 $1,499

Normalized EBIT Margins

Advertising 20.0% 20.0% 20.0% Mgmt. has guided for 30% - 35%

Food Delivery 10.0% 10.0% 10.0% GRUB is in the high teens

Subscriptions 80.0% 80.0% 80.0% Little incremental cost required

EBIT

Advertising $131 $174 $231

Food Delivery $7 $15 $23

Subscriptions $64 $76 $92

Total EBIT $202 $265 $346

Enterprise Value at 15x EBIT (Implies 12x EBITDA)

Advertising EV $1,970 $2,613 $3,465

Food Delivery EV $111 $226 $345

Subscriptions EV $953 $1,144 $1,373

Total Ent. Value $3,034 $3,982 $5,183

Plus net cash $375 $375 $375 Assumes cash flow is reinvested

Equity Value $3,410 $4,358 $5,558

Diluted shares 76.6 78.5 80.4 Bakes in annual dilution from SBC

Implied stock price $44.54 $55.54 $69.11

Current stock price $26.83 $26.83 $26.83

Upside 66% 107% 158%

Excluding subscription business

Implied stock price $32.09 $40.96 $52.04 Implies 2-3 year target price of $50

Upside 20% 53% 94%

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Advertising

Today, advertising is Yelp’s core monetization tool and represents over 90% of sales. I

conservatively estimate 2% user growth, compared to 3.7% growth in 2015, and apply 30%

growth in advertising / user growth, compared to 36% growth in 2015. By 2018 the advertising

monetization rate is projected to be $7.54 / monthly active user which is more in line with the

current peer monetization rate.

I assume the company can generate a 20% EBIT margin from its advertising business once it has

scaled up and de-emphasized user growth. Management has a slide showing its long term model

which has Adj. EBITDA margin of 35% - 40%. Backing out 5% for D&A, 5% for stock-based

compensation, and an additional 5% for conservatism gets me to my estimate of 20% operating

margin. This compares to EBIT margins of ~50% and ~30% at Facebook and Google.

Using a 15x EBIT multiple (implies 12x EBITDA), I arrived at an EV valuation for the

advertising business between $3 bn and $4 bn by 2018. This EBIT multiple is consistent with

Google’s current forward EBIT multiple and is a discount to Facebook’s forward EBIT multiple

of 22x. Yelp’s current enterprise value is $1.6 bn which implies that the advertising revenue

stream alone could be worth more than 2x the company’s current value.

Food Delivery

Yelp already has a rapidly growing food delivery business with Eat24. In the Q1 2016 LTM

period, Yelp generated $51 million in transaction revenue of which I estimate ~$45 million was

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food delivery related. I estimate Yelp’s top line potential for Eat24 by assuming 1%, 2%, and 3%

of Yelp’s monthly active users (excluding mobile app users) become active users of Eat24 in

2016, 2017, and 2018, respectively. Applying GrubHub’s average fee revenue per user of $50,

gets to my estimate for food delivery revenue. By signing up just 2% of Yelp users onto its food

delivery platform (a very natural fit), Yelp can create a food delivery business half the size of

industry leading GrubHub Seamless, a $2.4 bn market cap company.

Assuming a 10% EBIT margin to Eat24, compared to GRUB’s mid-to-high-teen EBIT margin,

and applying a 15x EBIT multiple, compared to GRUB’s 25x forward EBIT multiple, implies an

enterprise value of $300 to $400 million by 2018. I have notably ascribed no value to the many

of transaction related businesses that Yelp is already monetizing because they currently do not

contribute significant sales and investors have a limited view into the economics of these

businesses. Aside from food delivery, there is significant untapped potential upside from these

transaction related businesses.

Subscriptions to Business Users

Lastly I created a hypothetical stream of earnings from a subscription service which could

monetize value-add capabilities and marketing analytics already offered to businesses for free. I

believe that the real drivers of Yelp’s network effect lie on the consumer side of the equation and

that charging businesses to be a part of this valuable network would not be very disruptive. I

assume that Yelp could charge a nominal monthly fee of $10 and that 25% of registered

businesses on Yelp would sign up. Charging this nominal fee to a fraction of the current business

user base could generate over $100 million in annual revenue. I also believe that the incremental

margins on this business would be extremely high since the products already exist and have

assumed an 80% EBIT margin – Yelp would probably want to hire some additional sales people

to sign on customers.

Applying a 15x EBIT multiple yields an implied enterprise value between $1.2 and $1.4 billion

from the earnings stream. It is again worth noting that virtually all social networks have

corporate membership plans. While it may have made sense not to fully monetize the platform

when Yelp was still building out its presence, I believe Yelp is in that position today and is

leaving significant value on the table by not doing so.

Downside is Limited Due to Yelp’s Attractiveness as an Acquisition Target

There is little downside for shareholders at Yelp’s current valuation because of the platform’s

immense strategic value. Yelp is a unique asset that would be extremely difficult to re-create.

Online advertisers are under-exposed to local businesses and would jump at the opportunity to

acquire this large market segment representing a >$10bn addressable market. Simply put, if the

public markets do not reflect Yelp’s intrinsic value then it will likely be acquired.

Yelp would be more valuable to a larger company with better scale in advertising and synergistic

avenues of monetization. For example, if Google were to acquire Yelp, it could sell Yelp ads on

its ad exchange and embed Yelp’s local business ads into its other products such as Google Maps

or YouTube.

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Many of Yelp’s competitors have recognized this and Yelp has received numerous acquisition

offers in the past few years including from Google and Yahoo. In early 2015, Yelp was rumored

to have hired bankers to explore a sale. Media reports speculated that Yelp was considering

offers as high as $4 billion for the company. Fortune Magazine (“Can Yelp's CEO keep turning

down acquisition offers?” http://fortune.com/2015/05/15/yelp-ceo-stoppelman-sell-yelp/)

reported that CEO Jeremy Stoppelman went as far as to personally ask Elon Musk and Peter

Thiel on whether or not Yelp should be sold – they both advised against it. In July of 2015, Yelp

was reported to have ended its sales process.

I believe circumstances are different today which may make a sale of Yelp more likely. Since

trading for a high market capitalization of $7 billion in March 2014, Yelp’s market value has

fallen precipitously to its current $2 billion. Because Yelp has used stock based compensation as

an integral part of its employee package, CEO Stoppelman is likely dealing with increased

pressure from employees with underwater options and cheap stock. The prospect of a potential

sale above $3 billion today is much more tantalizing.

Microsoft’s recent acquisition of LinkedIn is a great example of a social network selling at a

premium acquisition price despite the public market punishing the stock. After LinkedIn reported

its Q4 2015 earnings, the stock fell 50%. Less than 6 months later, LinkedIn announced its deal

with Microsoft. While there are certainly benefits to the combination, many commentators have

speculated that because LinkedIn has been a heavy user of stock based compensation,

management likely felt pressured to keep the stock price up in order to retain talent and keep the

value of their pay packages.

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There is also no straight forward way to determine what Yelp would be worth in an acquisition

scenario. However, given the high level of interest in Yelp as an acquisition target when Yelp

was trading at $3.5 billion, the answer is likely higher than the current $2 billion market cap.

Wall Street’s Negative Sentiment Towards Yelp is Overdone

According to Capital IQ, the average sell side analyst rates Yelp at “Hold”. The bear case against

Yelp points out that the company is unprofitable and user growth is decelerating. Bears believe

that Yelp is an inferior social network because local advertising requires a larger sales force and

is tougher to monetize. Finally, a forthcoming negative documentary “Billion Dollar Bully”

could expose negative practices the company has used to extort its customers.

While Yelp’s user growth may be decelerating, monetization of the user base growing at a rapid

pace. Wall Street analysts currently model that Yelp will turn a profit by next year; earnings

growth from there will likely accelerate as the company builds scale in its advertising business,

Social Media Precedent Transactions

Date Enterprise Target Financials EV / EV /

Announced Target Acquiror Value Sales EBITDA Revenue EBITDA

6/13/2016 LinkedIn Microsoft $26,399 $3,214 $266 8.2x 99.2x

2/19/2014 WhatsApp Facebook $19,697 $10 $0 1931.1x N/A

6/11/2013 Waze Google $966 N/A N/A N/A N/A

5/20/2013 Tumblr Yahoo $1,100 $15 $0 73.3x N/A

10/9/2012 Vine Twitter $970 $0 $0 N/A N/A

6/25/2012 Yammer Microsoft $1,200 N/A N/A N/A N/A

4/9/2012 Instagram Facebook $1,010 $0 $0 N/A N/A

Median $1,100 $10 $0 73.3x 99.2x

Note: US dollars in millions.

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grows transaction based revenue, and more advertising comes from self-serve customers (de-

emphasizing the sales force).

Ultimately Yelp is not going to be as profitable as Facebook or Google because of the hand

holding required in local advertising. However, Yelp will still be extremely profitable and should

be able to generate EBIT margins above 20% in the not so distant future. Furthermore, the

difficulty of building a business around local advertising networks provides for a deep

competitive moat.

Finally, the accusation that Yelp pushes around its customers has been around ever since Yelp

became an influential marketing tool. Small businesses with low Yelp ratings accuse Yelp of

writing negative reviews or of emphasizing those reviews on their profiles. To the contrary, Yelp

takes the legitimacy of its reviews very seriously and has created a filter to track and delete

reviews that appear fake or appear to have been written by bitter local competitors.

In 2014, two putative class action lawsuits were filed against Yelp alleging the company bullied

its customers and fabricated misleading statements on the platform. In 2015, the lawsuits were

consolidated and the U.S. District Court dismissed the case in April 2015. In November 2015,

the court dismissed the first amended complaint with prejudice and entered judgment in Yelp’s

favor on December 28, 2015. The plaintiffs have filed for another appeal which is still pending.

The U.S. Federal Trade Commission also looked into these complaints against Yelp and

concluded a year-long investigation without taking any action.

Concluding Thoughts

Yelp is an indispensable service for both consumer and businesses which helps solve the

information gap that exists in local commerce. The accumulation of 12 years of user generated

content and an incredibly active and loyal user base has created a network effect which makes it

extremely difficult to launch a competing service.

The market has discount the value of Yelp’s platform because its revenue model is immature.

However, over the next 3 years as the company shifts its focus to monetization and generating a

profit, the market will likely to re-rate the stock higher to better reflect its untapped value.