Yelp is hoping to raise $100 million when it goes public but a close look at its IPO disclosure with the SEC shows that if the shopping and restaurant review site doesn’t change its business model it may never make money. Although Yelp made $58 million in revenues during the first nine months of 2011 — the majority of which comes from advertising — it took a net loss of $7.6 million and has never been profitable over the last three years, according to its S-1.
That would not be a problem if the revenue/cost trend lines were moving in the right direction: The $100 million raised by going public could cushion the company while it develops a new business plan to make itself profitable.
Right now, unfortunately, that does not appear to be happening.* Yelp’s revenues (the blue line in the chart below) and its total operating costs (the green line) are in lockstep. It’s as if the company cannot generate revenue without first laying out an even greater amount in sales and marketing expenses (the red line) plus overhead (rent, tech stuff, etc.).
Ideally, you’d want to see the blue line closing in on the green line, or even rising above it. That would indicate that something is going right at Yelp. But that’s not happening right now:
Yelp actually warns about this on page 6 of its S-1:
“We have incurred significant operating losses in the past, and we may not be able to generate sufficient revenue to achieve or maintain profitability. Our recent growth rate will likely not be sustainable, and a failure to maintain an adequate growth rate will adversely affect our results of operations and business; …”
“Not be sustainable” would be the key words in that statement. One contributing reason Yelp’s current business model is unsustainable is due to the fact that it needs to pay hundreds of sales staff to generate ads on its site. In 2010, 350 of its 500 employees were employed on its salesforce. Applying that same proportion to its current headcount of 852, Yelp might currently employ 596 salesmen and women.
Yelp said in the S-1:
“The increase [in its sales and marketing costs] was primarily attributable to an increase in headcount and related expenses of $11.3 million as we expanded our sales organisation. As a result of our increase in net revenue, our commission expenses also increased $1.6 million.”
In other words, the more ads Yelp’s sales staff sells, the more commission Yelp must pay them, and the less profit Yelp keeps. The only good news is that sales and marketing appear to be a decreasing proportion of the company’s revenues. If Yelp can also get the rest of its operating costs under control — product development and administrative expenses — then it may eventually actually make money.
But Yelp doesn’t have Groupon’s cash flow advantage to help it do that. Yelp and Groupon are similar businesses — they both employ huge sales forces to sell local merchants on ads. Groupon, however, books sales from customers immediately and then delays passing on the merchants’ share for 30 days or more. That “float” gives Groupon positive cash flow it can use to fund its operations while it figures out how to actually become a real business.
As Yelp’s cash flow statement indicates, it doesn’t have that time-lag advantage, and it sees very little temporary positive cash flow from its operations.
Bottom line: Yelp is Groupon without the cash flow.
*Correction: The original version of this post, including the chart, said incorrectly that Yelp’s sales and marketing expenses were solely responsible for Yelp’s unprofitability. That’s wrong. Apologies.