Why Yelp Is Up After Missing Earnings Expectations

Yelp is doing well on the revenue line, but missing earnings expectations. Is this steady growth sustainable?

Feb 6, 2014 at 3:00PM

Nearly all consumer-focused companies were challenged by slowing demand this quarter, but Yelp (NYSE:YELP) beat revenue expectations, despite focusing on an end market that is the most discretionary of all: restaurants. How did this happen? If consumers are cutting back, aren't restaurants cutting back as well?

Accelerating growth is the story
The answer could be as simple as, "Yelp enables those restaurants to make more money."  Institutional investors can see it in the numbers; in the long term, all stocks are priced on a multiple of earnings or cash flow, but not while the company is building its customer base. At these early stages, large investors actually want the company to spend its revenue to keep that growth rate up. Yelp is doing that and it's working. In fact, revenue growth is actually accelerating:

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For the quarter, revenue of $71 million beat consensus of $67 million, but EPS of -$0.03 was a penny behind expectations of -$0.02. Guidance for next quarter's revenue was $74 million, slightly ahead of the $73 million estimate, but this is the first time that 2014 was offered. For the full year, Yelp is guiding analysts to $353 million-$358 million, ahead of the current $347 million.  

Difference between Twitter and Yelp's quarters
There are some key differences between Yelp's quarter and Twitter's (NYSE:TWTR).  In the case of Twitter, slowing growth is the concern. In the quarter, Twitter's revenue grew 116% year-over-year, but only 3.2% sequentially, which wasn't enough for some investors.  On top of that, monthly active users increased, but only from 232 million to 240 million between September and December. Twitter's interface is terrible, which may be part of the reason it doesn't have the same widespread appeal as Facebook, yet. This is something the company is likely to address through an acquisition that may reaccelerate growth, but in the meantime, Twitter investors should brace for a wild ride.

Yelp's competitive moat is widening
Yelp is a revenue story, not a profit story, and next year's guidance indicates there are more chapters in this book.  What makes Yelp different from many of the other advertising companies is the way it is trying to create a feedback loop with its clients. In 2013, Yelp launched several new products in an effort to create an information loop with local businesses. New products included: Yelp Platform, Revenue Estimator, Call to Action, and Customer Activity Feed.

The two most interesting, in my opinion, are Yelp Platform and a reservation system.Yelp Platform enables consumers to go from discovery to transaction directly on Yelp's website, and is now generating over 10,000 food orders each week. The reservation system comes from the SeatMe acquisition, a web and iPad app-based reservation solution for restaurants and nightclubs. It has a very low cost to customers and is free to use through Yelp's consumer website. The picture below shows how the functionality is built into Yelp's website:

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Source: Yelp

The beauty of this system is twofold: when people use this method to make reservations, there is no question about who helped generate the business and it makes Yelp's clients less likely to drop the platform for another source of advertising.

I'm a big advocate of Yelp, and I hope the stock does well, but I just cant trust the valuation. There is no earnings support if the revenue growth slows. For that reason, it wouldn't be appropriate for some investors. That said, this story is reminiscent of Amazon and Netflix, both of which I missed out on.

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David Eller has no position in any stocks mentioned. The Motley Fool recommends Twitter and Yelp. 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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