YELP - Yelp: Activist Pressure Might Lead To A Company Sale

2023-06-16 12:51:36 ET

Summary

• Activist investor TCS Capital Management has acquired a 4% stake in the service-recommendation platform Yelp and is pushing the company to explore strategic alternatives.
• The activist has pointed out that the company might be an attractive acquisition target to potential financial and strategic buyers.
• TCS has estimated that Yelp might be worth c. $70/share in a sale scenario, implying a 90%+ upside from current share price levels.

This is an interesting recently announced activist campaign that might potentially result in a company sale. It is far from clear if pressure from the activist can catalyze a transaction here given management’s unwillingness to sell the company in the past. However, I think that at current share price levels the downside is partially protected by the company’s seeming cheapness and solid fundamentals, including high margins, strong growth and solid balance sheet.

Yelp ( YELP ) is a $2.5bn market cap company that runs an online platform allowing users to discover and review local businesses, such as restaurants, hotels and home services providers. The company has recently come under pressure from activist TCS Capital Management (owns 4%). In its public letter , the activist has claimed that Yelp’s stock has in recent years significantly underperformed vs. the broader market under the current management team led by the long-time CEO/co-founder Jeremy Stoppelman (owns 6% out of 7% held by the entire management team). The activist has been pushing Yelp to explore strategic alternatives, including a company sale to a strategic or financial acquirer. Interestingly, TCS Capital has stated that it would be willing to make a bid to acquire the company itself. The activist expects the company to fetch over $70/share in a potential sale, implying a 90%+ upside from current share price levels.

Relative and historic valuations seem to suggest that the activist’s share price target is reasonable. Yelp currently trades at 6.2x 2024E consensus/activist’s estimated EBITDA. TCS Capital arrives at its share price target valuing the business at 12x 2024E EBITDA. I think such a multiple would not be excessive given Yelp’s pristine balance sheet (net cash position of $414m), solid growth (8-30% annual topline growth since 2016 excluding the COVID-induced decline in 2020), high margins (gross margins >90%) and regular free cash flow generation ($100m+ in annual FCF since 2017). An important caveat here is that a significant portion of Yelp’s adjusted EBITDA comes from stock-based compensation - SBC accounted for 57-63% of total adjusted EBITDA in 2017-2022 (excluding 2020). Assuming a similar proportional addback from SBC in 2024, Yelp would be currently valued at 15x 2024E adjusted EBITDA excluding SBC. Having said that, even after deducting SBC there seems to be headroom for an offer above current share price levels. While there are no directly comparable peers, similar-sized home services-focused competitor Angi (provides reviews and ratings for business providing services such as home improvement) is currently valued at c. 19x 2024E EBITDA ex-SBC (assuming it reverts to pre-pandemic levels as a percentage of adjusted EBITDA). Another reference point here is Just Eat Takeaway’s $7.3bn acquisition of food delivery platform GRUB in 2021 valuing the target at 31x/39x FY18/FY19 adjusted EBITDA (includes SBC). Historically, Yelp was valued at 23x-44x TTM adjusted EBITDA ex-SBC in 2017-2021 (other than in 2020).

Aside from a potential company sale, TCS Capital has stated that Yelp might explore a merger with its peer Angi. TCS has highlighted that a potential merger with ANGI would be highly strategic, leading to significant cost and revenue synergies given the overlapping business models. The activist has stated that a potential transaction would create a dominant player within the large $500bn US home services market. An interesting aspect here is that TCS has previously led a successful activism at Angi. Back in 2015, the activist came out publicly, pushing the company (Angie’s List at the time) to explore strategic alternatives, including a sale to IAC’s consumer review-site HomeAdvisor. The activist subsequently won a board seat at the company in 2016. Angie's List was eventually sold to IAC and was merged with its HomeAdvisor business in 2017. Worth highlighting that IAC’s unsolicited acquisition proposal in 2015, which came shortly after the activist’s letter to Angie’s List, was initially rejected by the incumbent management.

The main risk here that might explain Yelp’s undervaluation is company management’s unwillingness to sell the business. TCS Capital has stated that the CEO/co-founder Stoppelman “has rejected credible takeover offers from multiple suitors” in the past. Yelp was previously involved in acquisition rumors a number of times, including reported/rumored interests from Google (2009) and Groupon (2019). M anagement is very well compensated, with the CEO pocketing $41m in total compensation over the last five years, implying that the leadership is not incentivized to launch a sale process. Having said that, in recent years YELP’s leadership has initiated several positive changes, including the collapse of a dual-class share structure in 2016, appointment of five independent directors in 2019-2020 and a phased board declassification launched in 2021. It's worth noting that several of these developments, including the appointment of independent directors, came after pushback from activist investor SQN in 2018-2019, indicating management’s openness to strategic changes. Combining these aspects with a sizable ownership stake of the management, I would not be surprised to see it eventually willing to consider a company sale. A noteworthy fact is that Stoppelman was rather aggressively selling down his stake in the company in January ’23.

Yelp

Yelp runs a website and a mobile app that provide local business reviews and information. The vast majority of the company’s revenue comes from advertising while a small portion of sales are generated from transactions executed via Yelp. 40% of advertising revenues come from restaurants, retail and other (RRO) subsegment while other services account for the remaining 60%. Yelp boasted 73m unique visitors in 2022 (monthly average) and has 265m cumulative reviews.

Yelp is a quite well-known value play that has been extensively written-up on Seeking Alpha and Value Investors Club (see write-ups from 2019 and 2015 ). Since the massive share price drop in 2014-2015 on the back of rapidly slowing growth rates, Yelp has not recovered to 2014 share price highs. However, the company has since continued to consistently compound its topline and generate significant EBITDA/cash flows (see charts below). Within the context of these dynamics, Yelp has attracted a number of investors who have argued that the company’s growth slowdown has been temporary and likely to eventually pick up given the large local internet advertising total addressable market, potential for much more efficient click monetization and involvement of an activist investor SQN, among others aspects. To help drive up the slowing topline growth, Yelp launched a strategic transformation in 2019, focused on the launches of new products and features as opposed to expanding its salesforce. However, the business then got hit by COVID lockdowns in 2020. While Yelp’s topline has picked up significantly in 2021 and 2022, the company’s efforts have so far failed to bring revenue growth to higher levels. I am not sure if management’s strategic transformation efforts can bring any sizable topline expansion in the upcoming years as the business is likely behind its growth stages and has saturated its customer base, as also indicated by management’s 9% 2023 revenue growth guidance.

Other Risks

• One of the business-related risks here is potential AI disruption given the increasing popularity of generative AI chatbots such as ChatGPT and Bard. The chatbots are already able to scrap the data and provide summaries instead of customers needing to visit websites such as Yelp. However, Yelp’s management has noted that despite the already existing summaries in Google, website clicks have remained robust given the customers’ need for more information on local businesses. Moreover, the majority of clicks on Yelp have come through the mobile app, meaning that Yelp largely does not rely on Google or other search engines.
• Another aspect here is significant stock-based compensation that accounted for around half of the company’s adjusted EBITDA in 2022. SBC stood at 13% of revenues in 2022, however, management targets a decrease to 8% of revenues by the end of 2025, driven by a shift in compensation from stock to cash.

Conclusion

Yelp currently presents an interesting value play with a likely near-term catalyst. The involvement of activist TCS Capital, which has already led a successful activist campaign in the same industry, has the potential to drive a company sale or a reverse merger here. I would expect any potential transaction to come at a significant premium to current share price levels. While there is no guarantee a company sale/merger will materialize here, at current share price levels the downside seems fairly well protected given the company’s cheapness and strong business fundamentals.

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