Yelp: Fighting to Live Up to Expectations
Yelp (NYSE:YELP) recently reported financial results for the fourth quarter of fiscal 2019.
Revenues for the period increased 10%, culminating in an 8% increase for the full year to more than $1 billion in revenues. The growth in 2019 reflects a significant increase in ad click volumes (up 34%), offset by a nearly 20% decline in the average cost per click. Note that revenues increased by 10% in the back half of 2019, compared to 5% growth in the first half of the year. Management expects another acceleration in revenue growth in the coming year, with initial guidance calling for a 10% - 12% increase in 2020 (to more than $1.1 billion in annual revenues).
As shown below, Yelp's revenues have increased by roughly 170% over the past five years.
The company is seeing continued success among its multi-location customers, with a 22% increase in 2019 (these customers now account for roughly one-quarter of Yelp's advertising revenues). Of the top 250 restaurants and retailers in the United States, more than one-third are now paying customers of Yelp. Importantly, the growth from larger clients consisted of both rising engagement among existing advertisers and the addition of new accounts. As I've noted in the past, I take comfort in that because I believe this category of customer is likely the most capable at understanding the efficacy of its ad spend. If they are allocating additional dollars to Yelp, it's because they are seeing returns that justify incremental investment.
User engagement continues to grow as well, reaching 36 million app unique devices in the quarter (up 8% year over year), along with a 16% increase in cumulative reviews (to more than 205 million). That said, as shown below, the pace of app unique device growth was cut in half throughout 2019 and is meaningfully below what it was 2-3 years ago. While that partly reflects the reality of trying to sustain growth off of a larger base, I do find the rapid deceleration concerning (they added roughly 2.7 million net devices year-over-year in the fourth quarter, compared to an average of 4.3 million devices added per quarter over the past two years).
More importantly, management believes that trend will continue:
"As we leverage our Restaurants category investments to drive user engagement, we will likely see slower App unique device growth in the short term. However, we believe the higher quality traffic and independent distribution will be far more beneficial for Yelp and its shareholders in the long term."
My take, and this is putting it kindly, is that they found a passable narrative to fit the trend.
Across the platform, Yelp continues its work to move beyond the legacy directory and review offering. They're providing additional ways for business owners to tell their story and engage with consumers, including profile products like Verified License, Business Highlights and Portfolios. These offerings have largely been useful for businesses in Home & Local Services, which is Yelp's largest vertical and grew double digits in 2019. As the company continues to expand its offerings and improve its ability to match consumers with businesses (with Request A Quote being a notable example), I think there's an opportunity for growth ahead (to put some numbers of it, fewer than 20% of all paid leads in Home & Local Services are currently being delivered to advertisers).
A shift towards self-serve advertisers (with revenues from this channel up 30% in 2019) and larger accounts means Yelp can generate the same dollar of revenues with fewer salespeople. As a result, overall sales headcount declined mid-single digits in 2019, with the local sales headcount down 10%. In addition, the company is moving its workers away from high cost locations like San Francisco. Management expects similar trends in 2020, with another decline in the local sales headcount offset by an increase in multi-location sales personnel.
The reduction in sales headcount, combined with the 8% increase in revenues, led to operating leverage. In 2019, Sales & Marketing expense was equal to 49.3% of revenues - an improvement of 200 basis points. The improvement in local sales force productivity was the primary driver of the expansion in adjusted EBITDA margins (to 21% in 2019), with adjusted operating income increasing to $43 million (inclusive of the cost of stock-based comp). Based on long-term guidance of adjusted EBITDA margins of 30% - 35%, it's clear that they expect this trend to continue; specifically, as it relates to 2020, management expects another 100 - 200 basis points of margin expansion.
Yelp currently has $466 million in cash and equivalents and no long-term debt, which amouts to more than $6 per share of net cash. The company has accelerated the pact of capital returns to shareholders, with $481 million of share repurchases in 2019 at an average cost of $34 per share. The result was a 12% decline in the average diluted share count. While the pace of repurchases will almost certainly slow going forward, the strength of the balance sheet still gives them flexibility.
Cash from operations for the year was $204 million, up 28% from 2018; however, a lot of it is attributable to stock-based compensation. Personally, I'm still torn on how to think about this, especially when you're offsetting the effect of issuance with significant repurchases (note that the board of directors just authorized an additional $250 million increase to the repurchase program). For now, my answer is to assume some share creep in my financial model or to account for the cost that it will take to keep the share count unchanged. One thing I do know is that stock based comp is a real expense and should be properly accounted for when calculating per share earnings power.
Conclusion
As CEO Jeremey Stoppelman noted in the press release accompanying the fourth quarter financial results, the company has "confidence in our ability to achieve our long-term financial targets... we believe our long-term growth trajectory remains squarely on target."
The market disagrees. Anybody that builds a financial model based on management's long-term guidance will clearly see that Mr. Market remains skeptical that the company will even come close to hitting these targets. Personally, I agree with that conclusion - and I'm more convinced given the somewhat lackluster 2020 guidance.
However, I think that is already priced in. When I run the math, I still think the risk/reward is reasonable. For that reason, I continue to be a Yelp shareholder.
That said, my personal opinion is that we've seen some cracks in the story, including the relatively short tenure of former CFO Lanny Baker. For that reason, even though the upside in the event of favorable business results could be huge, this is far from my highest conviction position. If I'm given the chance to add at a lower price, I will likely do so - but even then, I'd be somewhat cautious with the position sizing.
Disclosure: Long Yelp.
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This article first appeared on GuruFocus.
