Yelp (NYSE:YELP) is one of the largest online recommendations site and features services such as business search, review and recommendation. It enables consumers to access ratings and read reviews and opinions about local businesses like hotels, restaurants, dentists and mechanics etc. on their website. Local businesses are reviewed and rated by customers who become contributors to the website. Yelp generates revenue mainly from local business advertising, display advertising and from additional services like Yelp deals, and deals with reservation services like OpenTable (NASDAQ:OPEN).
The stock price has jumped significantly in the last few week, ballooning by more than 30%, as short covering pushed the price up to $25. Yelp’s IPO lock-up expired on August 29th and as with a lot of technology IPOs in the social networking space, traders expected the stock to fall as investors and company insiders sell the stock. As most of the company insiders and early venture capital investors chose to hold onto their stakes and not divest, there was a huge short squeeze which led to the spike in Yelp’s stock price.  Yelp’s fundamentals seems to be improving as Chief Executive Officer, Jeremy Stoppleman, announced that click-through rates on its mobile site, is significantly higher than its desktop traffic. 
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We currently have a $12.20 Trefis price estimate for Yelp based on its current earnings, monetization plans and growing operating expenses. Yelp reported a solid 67% y-o-y jump in net revenues in Q2, with a revenue of $32.7 million. Reviews grew 54% y-o-y to more than 30 million, and the average unique monthly visitors grew to 78 million. Active business accounts grew 113 percent y-o-y to approximately 32,000. For Q3, the company has guided for net revenues in the range of $34.5 million to $35.5 million with adjusted EBITDA of $750K to $1.25 million. Despite healthy revenue and visitor growth, we maintain a significant downside compared to its current market price, based on the current operating expense levels and monetization levels.
High Growth Mobile Business Yet To Be Monetized
An estimated 25% of unique users come from mobile phones, and Yelp mobile applications are being used on 7.2 million devices each month, up 70% year-over-year. This surge is led by the maps integration in iOS 6. Mobile penetration with Yelp users is high, with almost 40% of searches occurring on mobile and 50% of photos contributed by users are also from mobile phones. Yelp does not run any ads on its mobile app and we can expect significant revenues from the mobile app in the future, but currently there is no monetization and the mobile app is growing fast and spreading internationally. Yelp currently operates in nearly 90 cities with Q2 witnessing launches in 8 new markets, including international markets such as Denmark, Finland, and Norway.
Local Advertising Growth Fairly High, But Slowing
Yelp’s biggest source of revenue is local advertising, and has the greatest impact on its Trefis price estimate. Local ads generated $25.3 million in Q2, up 89% y-o-y. This is much lower than its growth in the past two years where it had almost tripled, but due to a higher base, it is expected to slow down. We expect the revenue growth to slow down in the coming days, till the mobile app is monetized.
Yelp is expanding outside the U.S., and we expect its average revenue per business to decline, as businesses in developing economies generally spend lesser on advertising than American businesses. Yelp has made inroads into Denmark, Finland and Norway, and we expect the lowered economic outlook in Europe to contribute to the decline in ad spending by businesses. The company expects full year revenues of $135-$136 million, which is a 62-63% y-o-y growth and adjusted EBITDA of $3-$4 million. Yelp is rapidly becoming “a de facto search engine” as users prefer Yelp over other search options when it comes to reviews. 
Display Advertising Facing Competition
Brand advertising was the second largest source of revenue for Yelp, but it currently accounts for around 13% of Yelp’s value. Revenue from brand advertising was $5.7 million in Q2, up 27% y-o-y. Yelp’s online platform saw an average of around 78 million users every month in 2012, and we expect the count to grow to around 226 million by the end of the forecast period. The growth in online visitors will be driven primarily by an increase in the number of consumers searching for local businesses online, in Yelp’s existing markets as well as the markets it plans to expand into. Our forecast is based on the assumption that Yelp will see reasonable success and be able to attract users in the new markets it enters, and there’s always the risk that it may not be able to.
The average advertising revenue per unique visitor is bound to decline as it continues its expansion outside the U.S., and also due to increasing competition in the display advertising market. Yelp is a very small player compared to giants like Facebook, Google, Yahoo etc.
Yelp Deals and Reservations
Deals, Partnerships and Other Services is currently the second most valuable division and accounts for 15% of our current estimate of Yelp, despite tremendous competition in the daily deals space with juggernauts like Groupon and LivingSocial. We expect Yelp to significantly grow its revenue from deals and other services through the forecast period, reaching almost $80 million by the end of our forecast period.
Operating Expenses A Growing Concern
The single most important factor that drives Yelp’s value after its revenue growth is the growth in its operating expenses. Yelp’s operating expenses accounted for almost 110% of its overall revenues in the first two quarters of 2012, with SG&A expenses accounting for 92% and R&D expenses accounting for 14%. This is up from 82% and 13% y-o-y and should ideally fall as the company becomes well known for recommendations. We expect SG&A costs to decline to around 50% of its revenue by the end of the forecast period, despite that fact that Yelp’s planned expansion spree will lead to increasing SG&A expenses, as Yelp will have to increase its marketing and operational costs to sustain its growth in new markets. If Yelp gains a significant following and these costs reduce, we can expect a significant upside to its Trefis Price Estimate.Notes: