ANGI - Yelp: Bullish Growth Catalysts Moving Into Q4

2023-10-11 11:40:06 ET

Summary

• Yelp's well-known brand image and trusted content contribute to its continued margin expansion and lower traffic acquisition costs.
• The company has seen significant growth in adjusted EBITDA and net income margins over the past few years.
• Yelp has a significant monetization opportunity in service categories and has implemented an impressive capital return program through share repurchases.
• Potential merger plans and shareholder activism/takeover have added additional opportunity to YELP.
• AI capabilities will continue to drive customer interaction and quality of clicks to the advertisers.

Investment Overview/Thesis

I am rating Yelp Inc. ( YELP ) as [OVERWEIGHT] and a [BUY] moving into Q4 of 2023 because of various growth catalysts, including but not limited to:

• Yelp's competitive moat will continue to expand due to its well-known brand image, trusted content, and lower traffic acquisition costs.
• Significant expansion has occurred across net income margin and adjusted EBITDA over the last few years. Net income margins are up roughly 6% in three years. AEBITDA margin is at 23%. Both were up 200 bps YoY in 2Q 2023.
• When looking at its core competitors (TripAdvisor, IAC, Nextdoor), Yelp is currently trading at a premium in terms of FWD P/E (14.4x) and FWD EV/EBITDA (7.8x) than it has historically due to its innovative advertising tech-stack capabilities and competitive moat.
• U.S. local digital media advertising spending is a robustly growing market expected to expand at a CAGR of ~5.3% from 2022-2027, up to $272 billion.
• Yelp has a significant monetization opportunity in Service categories. Millions of leads are generated daily on Yelp, and ~25% of these leads in services were monetized in 2022 (vs. <10% in 2018). Leads include phone calls, website clicks, mobile check-ins, Yelp bookmarks, etc.
• Impressive capital return program through share repurchases of over $1.2 billion since 2017.

My 1-year price target for Yelp is $55/share, implying roughly a 30% return from the current share price of $42.83.

Company Profile

Founded in San Francisco in 2004, Yelp Inc. engages in a community-driven platform that connects people with local businesses. Millions rely on Yelp for practical and trusted local business information, reviews, and photos to help inform their spending decisions.

Yelp primarily operates through two business segments comprising over 95% of the company's revenues: Services Advertising and Restaurants, Retail, and Other Advertising (RR&O). There is also a transactions business segment accounting for around 2-3% of the total company sales. Advertising for services contributed ~58% of FY '22 net sales at $694 million, while RR&O advertising was ~37% of sales for $441 million. Home services was the strongest service performer.

Although Yelp has dramatically outperformed the stock returns of its direct competitors (i.e., TripAdvisor ( TRIP ), Angi ( ANGI ), and Nextdoor ( KIND )), it has underperformed mega-cap competitors like Alphabet (GOOG) ( GOOGL ) and Meta ( META ). On a 5-year basis, the story is the same; however, the S&P 500, in the same 5-year timeframe, has seen total returns of 48.60%, while Yelp is down around 10%. Investors have seen recent share price momentum, likely due to substantial Q2 '23 numbers, increased Q3 and FY guidance, and shareholder activism activity from TCS Capital Management, which I will get into later.

"Be Greedy Only When Others Are Fearful"

As the old Warren Buffett saying states, " to be fearful when others are greedy and to be greedy only when others are fearful, " this is an exceptional time to buy when most are fearful. The lackluster returns on Yelp have pushed investors and sell-side analysts away, heightening the downside pressure on the stock and making it an excellent opportunity to buy. Moreover, the sell-side has been extremely bearish on this name, with only 11 total analysts covering the name and three sell ratings, six holds, and only two buys, for an average price target of $43.75 (only 4.29% indicated upside from the current share price). Below depicts the bearish nature around YELP stock, which is mainly driven by poor management performance and high stock-based compensation, in my opinion. Also, recent shareholder activism can be a contributor to this uncertainty.

As you can see, the street has generally been bearish or neutral on this name. Moreover, neutral ratings on Wall Street tend to be slightly bearish, while sell ratings are extremely bearish. Considering the bulk of the ratings are holds (neutral), and more sells than buys, Yelp has been an undesirable stock in the eyes of equity analysts. This poses an unprecedented opportunity in my opinion, given potential merger ideas, and the current market comeback in advertisement expenditure/CPC.

Many investors look at the past and see egregious stock-based compensation plans as a percentage of revenue, which has concerned prospective buyers. This is another area where I see a significant opportunity in the name. While stock-based compensation in the past ranged from 12-15% of net revenue from 2019-2022, management targets lower than 12% for 2023 and 8% by 2025. This target was stated in the last earnings call in early August. This is an aggressive target, and if achieved, there will be far less dilution and more room for management to deploy capital elsewhere.

Key Bullish Catalysts

Some of the most attractive parts of my bull case here are the aggressive buybacks at low prices, merger potential with Angi, management's effort to turn over a new leaf and target lower stock-based comp., robust services growth (especially home services), further capitalization of AI capabilities and efficient markets like multi-location, and growth of average CPC.

First off, for share repurchases, management noted on the last earnings call that they repurchased $50 million more shares of YELP at an average price of $31.98/share. This was an excellent opportunity for management to strategically buy back shares at historically low prices/valuations, which conveys their true intentions to bolster shareholder value moving forward. Since the inception of Yelp's multi-year capital return program in 2017, they have bought over $1.3 billion in shares and have around $182 million remaining in authorization. The chart above from the investor presentation depicts the program timeline.

Stock-based compensation growth has been slowing sequentially and will continue to be a smaller share of the company's revenue to optimize shareholder value. If stock-based compensation continues to rise and outpaces sales and net income growth, I will reassess my view, as this is an essential catalyst to my thesis.

Additionally, since the activist noise from TCS Capital Management in May, the stock has run up substantially. Management President Eric Semler wrote a letter exercising his caution about the stock and management's red flags. He noted, " Yelp insiders have collectively sold nearly $120 million of stock since 2018 and none have purchased shares during that same period (except to exercise options). " With more than a 4% stake in the company, TCS is one of the more prominent owners of YELP, and an activist move can be the knight in shining armor for the stock and the company. Semler noted that a potential merger with Angi could be massive because of Yelp's outstanding balance sheet with more than $270M in net cash and its bolstering home services sub-segment. Additionally, the $500B+ market opportunity in Home Services alone is another catalyst for this transaction to go through. With $600M in EBITDA potential from this merger, Semler placed an exit price of $70/share, which seems reasonable, and the stock has only gone up since.

As you can see above, while clicks and paying advertising locations stayed relatively flat YoY, the average cost per click rose 14% in the same timeframe. This is the revenue Yelp is bringing in, and this is a great indicator of product resilience. Although we are in a tough spending economy/market where clicks aren't going up, the quality of clicks and leads on the platform continue to deliver positive ROI to the advertisers, driving up CPC.

Service ad revenue has grown nicely on par with impressive home services growth. Services saw 15% YoY growth, while home services specifically went up 25% in the respective timeframe.

Leveraging AI capabilities with neural networks (ML, improving leads) for better ad targeting is another critical driver in Yelp's bull thesis. Yelp uses neural networks to match consumers with advertisers more accurately and efficiently. Yelp recently rolled out an update that leverages neural networks to predict ad click-through rates and optimize ad placement for a given consumer more accurately. With a new chief product officer in place, Yelp has many more exciting things in store by focusing on a product-driven model moving forward.

Valuation Section

In this section, I will show my P/E valuation model, which has a 1-yr price target and a 7-yr price target on Yelp. The model reaches the year-end of 2030 and illustrates bearish, neutral/base, bullish, and average price targets. I also have a bull, base, and bear DCF model that is also on the file but won't be in this document.

For estimated revenue assumptions, I grew Dec '26-Dec '26 net sales by 10-11% and decreased the growth rate annually to 5.5% in Dec '30. These aligned with my 8.75% ST and terminal revenue growth rates in my base case DCF model (also shown below). These conservative estimates illustrate a strong US consumer and robust ad spending, paired with innovative AI capabilities in neural networks and machine learning to increase CPC, total clicks, interaction rates, and lead quality for the advertiser. An 8.61% CAGR return to a price of $74.76 is very reasonable given the current macroeconomic conditions, Yelp's place in the advertising space, and how I see the ad-tech market recovery playing out. Of course, this is just the neutral scenario, and many threats or potential upside drivers are not factored into this model. Overall, I think Yelp is at a very attractive entry point for both a medium-term and long-term investment, with merger potential at a much higher price/valuation.

Risks and Red Flags to My Bull Thesis

• Yelp is trading at a sizeable premium to its competitors and is relatively pricey on several historical timeframes. This can be seen as unattractive to prospective investors. Yelp's pricey multiples are justified by its cutting-edge AI capabilities, diversified product offerings, and inherent merger potential; however, if AI is already fully priced in, Yelp is expensive.
• Simply put, the current management is a red flag. Both Jeremy Stoppelman ((CEO)) and Joseph R. Nachman ((COO)) have salaries of $10,846,267 and $5,847,014, respectively. Both hold sizeable positions in the company but have not bought any shares recently (past five years) other than options exercises. Many of Yelp's past practices with stock-based compensation are sketchy and risky to the shareholders, but with new capital return initiatives, Yelp looks more attractive.
• The ad revenue market continues to see tepid growth. The last year or two have been rough for advertising revenue. If a higher for longer economy persists and continues to pressure the consumers' pockets, which will drag down ad revenue, companies will spend less on advertising. However, we have already seen advertising spending recovering, and Yelp notes that the U.S. consumer seems resilient.
• The current shareholder activist activity with TCS Capital Management can tarnish the name of Yelp and take out the current management. While this might be the best case for existing shareholders, other adverse implications can transpire.
• With less than 20% of sell-side ratings being buys, many institutional investors, retail investors, hedge funds, and asset managers are turned off from investing in this speculative play.

Overall, this is a wonderful time to buy into the name. Even though we have seen impressive returns in the first three quarters of 2023, there is plenty of room to run and even an attractive long-term position if there is more news on a merger taking place or new management initiatives. For now, I have a buy rating with a price target of $55/share for next year.

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