Yelp's good stock day may be a bad sign
You know things aren't going a company's way when a good day in the stock market is driven by little more than speculation. So it is with Yelp, which saw its stock rally 7 percent Friday to its highest level in more than four months because... well, it's not really clear why.
Yesterday, a Yahoo executive in charge of M&A said in passing that the company was working on two “significant” acquisitions and six smaller ones. It's hardly surprising but certainly noteworthy, and so AllThingsD's Kara Swisher picked it up, adding her thoughts on possible targets like Pinterest, Tumblr, Hulu or Flipboard among others. Notably, Yelp was not mentioned.
Yet that simple flap of a butterfly's wing appears to have inflated Yelp's market cap by $100 million Friday. Chatter of a Yahoo deal emerged on Twitter and elsewhere. The 7-percent rise was most likely driven by short sellers, who have been building up Yelp's short interest in recent weeks, who were buying back shares to avoid being caught off guard.
So why is any of this worth noting? Speculative rumors often prove to be untrue, but the fact that it gathered momentum often reflects a deeper sentiment held by a lot of people. In this case, the rally says something interesting not just about Yelp, but about the recent generation of Web startups that have emerged as brand names in the past several years.
A little more than a year ago, on March, 1, 2012, Yelp went public at $15 a share. Since then, its stock has vacillated between $14 a share and $32 a share. In that sense, Yelp is faring much better than other companies that are trading below their offering prices: Facebook, Zynga, RenRan, Groupon, and Pandora. Those last two have announced the departures of their CEOs in the past two weeks.
Except for Facebook, which had its own particular IPO problems, the above companies have been posting intermittent or steady operating losses in recent quarters. Not the continuous profit growth that investors are accustomed to seeing in tech leaders or in healthy sectors of the stock market. Instead, most of these companies have enjoyed strong revenue growth, but often it comes at the expense of profits. Which, at the end of the investing day, is pretty much the point.
Yelp is a good example of this grow-today, earn-tomorrow ethic among recent IPOs. The company's revenue grew 65 percent in 2012, 74 percent the year before and 85 percent the year before that. But it's posted operating losses every year for the past five years -- an aggregate loss of $53 million during that period.
Analysts are expecting Yelp to post a net loss of 5 cents a share this year and a net profit of 19 cents a share next year. But even that profit gives Yelp a price-earnings ratio of 132 based on 2014 earnings. A lot can happen between now and then. A company like Google or Facebook, for example, could steal eyeballs from Yelp's useful reviews. Analysts know that estimates become ballpark guesses when they stretch too far into the future. In other words, more speculation.
Another risk facing investors is that Yelp, Groupon, Pandora and others are proving to be much better at attracting users than monetizing them. That revenues are growing quickly because more people are using their popular services, but that the cost of acquiring and keeping them is also growing. Or that competitors will compete with lower prices, pressuring down profit margins for the indefinite future.
If that proves to be true, then investors are going to grow even less enthralled with the stocks of publicly traded Web companies. And then the best option facing many of these companies will be to be acquired by a larger company that can absorb the thin margins or the operating losses and cut costs by integrating these companies into their overall operations.
That's why this speculative pop in Yelp's shares intrigues me. Not because Yahoo may or may not buy it, but because it might reflect an emerging sentiment in the market that it's just a matter of time before the Web 2.0 generation is consolidated into the hands of a few powerful companies. The longer it takes fast-growing revenue to translate into the bottom line, the more likely that consolidation will become.