YELP: Debating TAM

Takeaway: We realize there may be some confusion regarding our US TAM estimate for YELP. Below we clarify our analysis, and reiterate our estimates.

NOTE SUMMARY

  1. YELP's US TAM = 3.4M: We have segmented the market in terms of all US businesses by end-customer and income. Our 3.4M estimate is still generous, including two cohorts that may not be all that addressable.

  2. Peak Penetration = 170K: We've said that YELP's realistic TAM is 170K, but we realize our wording here is somewhat confusing.  We're referring to its peak quarterly penetration, not the total number of accounts that YELP will ever penetrate (we believe it has already penetrated in excess of this metric).  

  3. YP ≠ Low-Hanging Fruit: Management has suggested that YP's 575K accounts are a realistic target for YELP.  However, YP has a considerably larger TAM.  575K isn't the low-hanging fruit, it's a pipe dream.

YELP'S US TAM = 3.4M

YELP: Debating TAM - YELP US TAM 1

Consensus may argue that YELP’s total addressable market (TAM) is substantial, with a pool of 27M businesses in the US.  But after digging deeper into census data, YELP's TAM is considerably smaller.  Two things to consider 

  1. Can’t Afford: 75% of US businesses make under $100K in annual revenue.  YELP’s cheapest ad package is $3,600 annually.
  2. Wrong Audience: ~47% of US businesses are B2B, largely outside the scope of YELP’s core retail audience.

After netting out both B2B-focused businesses, and retail businesses with less than $100K in annual revenues, we estimate the total addressable US market is closer to 3.4M.  However, 3.4M is still a generous assessment.

Note the two business cohorts in the yellow boxes above.  In the first box from the left are businesses generating $100-$250K in revenue.  However, these are segmented by revenues, not profits, which means the price of YELP's ad packages may still be prohibitively expensive to this group as well.  For example, a business with $150K in revenue and a 20% operating margin generates $30K in profits; paying $3,600 for an ad package is still a prohibitive cost in this scenario.  1.4M businesses out of our 3.4M estimate lie within this cohort (40%).

In the yellow box to the right are businesses generating over $1M in revenues.  Many of these business are national businesses, which may be looking for broader reach outside of a local sponsored search results.  We're not saying that national businesses would not use local advertising, but that these businesses likely have more advertising options at their disposable, thus tougher accounts for YELP's reps to penetrate.  644K businesses out of our 3.4M estimate lie within this cohort (19%).

So while we estimate YELP's US TAM to be 3.4M, over half of that estimate may not be all that addressable.

PEAK PENETRATION = 170K 

We understand there may be some confusion here.  So below we will clarify how we arrive at this metric

YELP currently has 74K active local business accounts (ALBAs), which is only ~4.6% penetration of the 1.6M claimed business pages as of 1Q14.  YELP’s advertiser base has never exceeded 5.0% penetration of its claimed pages since at least 1Q10. 

YELP: Debating TAM - YELP   Ad penetration

But there is a more important point: YELP's recurring attrition issues will always drag on the number of accounts that it will report in any given period.  YELP can continue hiring more reps, and close more new business, but it will continue to lose more accounts as its business grows.  YELP's quarterly attrition rate has hovered in a relatively tight range since 1Q12 (18.7% average, with a standard deviation of 60bps). So unless there is a seismic shift in retention rates, penetration will always be capped by what will be a growing number of lost accounts on a quarterly basis moving forward (e.g. the 12K accounts that YELP lost in 1Q14 is roughly 1/3 of the total accounts it lost in 2013). 

So unless retention changes, which we believe will be dependent on future pricing decisions, we can't see how YELP will ever surpass its peak quarterly penetration rate of 5% by any material margin.  In turn, we estimate that YELP’s realistic peak penetration in any given quarter is 170K businesses (5% of the total 3.4M opportunity). 

YELP: Debating TAM - YELP   Attrition Q Rate ex Qype 1Q14

YELP: Debating TAM - YELP   Cum Lost Q

YP ≠ LOW-HANGING FRUIT 

We understand, that 170K may sound crazy relative to the consensus narrative, especially since management has implied that YP's 575K customers are the low-hanging fruit for YELP.  But when you compare the two companies, you can see that they are not actually comparable.  The bottom line is that YP has a materially larger TAM.  Some points to consider below

  • YP has a much broader product portfolio; Not all businesses are looking to do local sponsored search results, and while YP's customer count includes fading offerings like print yellow pages and direct mailing, there is still a demand for it today and that won't change overnight.  YP's broader portfolio means it is tapping a segment of the market that YELP cannot.  That alone means it has a larger TAM.  
  • YP can penetrate the B2B market: Services such as website design/hosting, and search engine marketing & optimization are not confined to the retail market.  YELP’s users are exclusively retail, so there is no basis to assume it can penetrate the B2B market, which is 47% of all US businesses.
  • YP has lower priced products: this is extremely important since 75% of all US businesses make less than 100K in revenue.  YELP’s cheapest ad package is $3600 annually, which is prohibitively expensive for most companies in the US.  YP's lower-priced offerings means it can penetrate a much larger segment of the market that YELP can't today.

YELP: Debating TAM - YELP   vs. YP DXM

Each of these points individually means that YP has a much larger TAM; collectively they suggest that the two companies aren't comparable.  So when we say that YELP's peak quarterly penetration will not exceed 170K accounts in any given period, are we really that crazy? Or does the data raise enough red flags to cast serious doubt as to what YELP can reasonably penetrate? 

If you have any questions, or would like to discuss further, let us know.  For additional detail, let us know if you would like to see our updated deck from our call last week.

Hesham Shaaban, CFA

@HedgeyeInternet