Yelp's in Pain

When Yelp (NYSE: YELP  ) went public last Friday, it certainly seemed like party time. As the newbie's shares soared higher and higher, some noted how smart the local business review site was to have snubbed Google a couple of years ago, as well as how silly those unbelievers were, who cautioned that the offering should have started around $12 (rather than $15). Before the closing bell, the stock was trading at $26. Already, though, there were murmurs: Is this sustainable?

As it turns out, not really. Squeals of delight on the day of Yelp's IPO turned into whimpers of disappointment the very next trading day, as share prices plummeted 15%, to $21. Then, the comparisons began: LinkedIn, Pandora, Groupon. Had yet another Internet commodity driven off the IPO cliff?

It's a bit early to say, but those analogies bear fleshing out. LinkedIn (NYSE: LNKD  ) , the professional networking site, has risen in value almost 17% over the past three months, but is still trading approximately 30% lower than its highest point on opening day. Pandora Media (NYSE: P  ) , the Internet radio giant, has also gained nearly 39% in the same time period, but still trades at around 55% of its peak. The list is not complete without mentioning the coupon king Groupon (Nasdaq: GRPN  ) , whose stock is currently 42% off of its highest trading price.

Valuation: A mysterious process
A big problem, it seems, has been the ability to value these Internet companies with any degree of certainty. This leads to all sorts of estimates, of which the highest usually becomes the price at the opening bell. Groupon's value ranged from $10 billion to $30 billion in the run-up to its IPO. Pandora, characterized by Mashable.com as having "never been in the black," seemed to base its opening price on the popularity of LinkedIn's IPO rather than its own profitability.

Which brings us to the question of Yelp's value. Taking a look at the numbers on WebProNews, it is obvious that Yelp is not making money. Last year, the company showed a net loss of $16.9 million, even though revenue was its highest ever, at $83.3 million. Like many websites, Yelp makes money selling advertising. Is there really that much advertising to go around? Perhaps.

So how did Yelp come up with its valuation? A clue may lie in a comment from the president of IPOdesktop.com, who predicted that there would be many people "who don't know valuation metrics" buying stock on opening day. It appears that many investors get caught up in the excitement, realizing a bit later that they probably paid too much for those shares, which later drop in value. Sounds like this happens a lot, doesn't it?

Sit out opening day
Unfortunately, it doesn't look as if Yelp will regain its shine anytime soon, especially once investors actually take a look at its balance sheet. Another problem is the site's dependence on Google for traffic, much like online game developer Zynga (Nasdaq: ZNGA  ) is dependent upon Facebook. Since Google recently purchased restaurant-rating company Zagat, there could be a conflict of interest developing. Then again, look at Zynga: The company is developing its own platform and is now trading quite close to its all-time high. Perhaps there is hope for Yelp, if it can learn to control its spending while continuing to bring in more revenue each year.

In general, however, it seems that investors would do themselves a favor by skipping opening day for these Internet-based companies (hint: Facebook) and jump in a day or two later. At that point, there might actually be some bargains.

While the next wave of Internet stocks certainly holds promise, they don't hold a candle to the kind of potential we see in some other tech stocks. To be sure, the mobile revolution is fully under way and it's changing the very face of computing. To help our readers understand the massive trend, The Motley Fool recently compiled a research report titled "3 Hidden Winners of the iPhone, iPad, and Android Revolution." Better yet, we made it free to our readers. If you want to see exactly which stocks we think have the potential to be long-term winners, just click here to access your free copy today.

Fool contributor Amanda Alix owns no shares in the companies mentioned above. Motley Fool newsletter services have recommended buying shares of LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On March 08, 2012, at 1:46 AM, singhsohi wrote:

    How much is the online revenue industry worth in total? Companies that seem to be suffering from this are yahoo, bing and google, to some extent. Yelp and Zyanga are two companies that just can't survive on their own. Yelp is dependent on google and Zyanga is dependent on facebook. IDK how yelp can have market cap of 1 billion dollars? Yelp has to be dependent on facebook or google in the future if not both. Panadora is independent platform that can be successful without having to partner with any external parties. Yelp is not worth a $1 billion dollars when it will be dependent on a third party for rest of its life to generate revenue.

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