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YELP: Only Gets Worse From Here (3Q14)

Takeaway: The model is broken. Moving forward, it’s going to get tougher for management and the sell-side to make up stories to the contrary

note summary

  1. 3Q14 BEAT, BUT UNIMPRESSIVE: Much of the upside came on a surprise surge in its Other Revenue Segment.  YELP’s core Local Advertising segment missed expectations on its highest attrition rate since 4Q12.  Despite some noise around some misleading metrics, 3Q14 pointed to further deterioration in its core account metrics
  2. 4Q14 GUIDANCE WORSE THAN THE MISS: Aside from guiding below street estimates, YELP provided segment-specific guidance on the smaller two of its three segments (<20% of revenue).   From there, we can estimate that guidance implies its core Local Advertising revenue growth decelerates from 66% in 3Q14 to 57% in 4Q14
  3. 2015 WILL BE A DISASTER: YELP’s business model is breaking down, which is most evident in new account growth that can’t keep pace with the growth in sales rep hires.  That means hiring more bodies can no longer sufficiently compensate for its attrition issues, and unless you understand that element of the story, you really can’t understand how bad 2015 will be. 

 

3Q14 BEAT, BUT UNIMPRESSIVE

  1. Local Advertising Came in Light, Despite the Beat: The beat came from YELP’s Other Revenue segment, which grew over 150% y/y ($4M q/q), and was largely driven by its new partnership with YP.com.  However, Other Revenues are expected to decline next quarter.  Local Advertising missed street expectations, as attrition continued to accelerate.  Absolute attrition levels continued to rise, which is to be expected simply because it has more accounts.  However, it attrition rate of 19.1% was at its highest level since 4Q12.
  2. More Noise, No Substance: The customer repeat rate was 75%, same as the prior two quarters, and a historical high.  Remember this is a measure of MIX, not retention.  Also, management stated that its non-deal account growth grew 66% y/y vs. the 51% in Active Local Business Account (ALBA) growth.   However, note that this metric includes SeatMe, which had very few accounts when YELP acquired it late in 3Q13.  The better question is what its ALBA growth was ex-SeatMe?

YELP: Only Gets Worse From Here (3Q14) - YELP   New vs. Lost Accounts 3Q14

YELP: Only Gets Worse From Here (3Q14) - YELP   Attrition Rate 3Q14

YELP: Only Gets Worse From Here (3Q14) - YELP   Customer Mix 3Q14

4Q14 GUIDANCE WORSE THAN THE MISS

During the call, management provided segment-specific guidance on the smaller two of its three segments (<20% of revenue).  From there, we can estimate that guidance implies its core Local Advertising revenue growth decelerates from 66% in 3Q14 to 57% in 4Q14.  Management mentioned a challenging 4Q14 comp from the migration of int’l accounts from its Qype acquisition back in 4Q13.  While this is notable headwind for account growth, it is a disproportionally smaller headwind in terms of revenue growth since international is lower ARPU product.  In short, the weakness is much more than just Qype.

 

2015 WILL BE A DISASTER

YELP’s business model is predicated on aggressive sales rep hires to offset its rampant attrition.  New account growth is failing to keep pace with its growth in sales rep hires, which means its model is broken, and it only gets worse from here.

 

YELP: Only Gets Worse From Here (3Q14) - YELP   Acct vs. Sales 3Q14

 

Consensus estimates for 2015 remain outside the realm of reason.  Their mistake is simple: If you don’t understand the attrition element to the story, you can’t understand the excessive number of new accounts required to hit 2015 estimates.  YELP will need to produce both accelerating new account growth and historically low attrition to hit consensus estimates, which are calling for 46% revenue growth. 

 

We expect estimates to come in moderately post the print, but likely not enough.  Our bull case is calling for 32%; bear case for 23%.

 

Let us know if you have any questions, or would like to discuss further.

 

Hesham Shaaban, CFA

@HedgeyeInternet

 

 



Oil, Russia and Europe

Client Talking Points

OIL

#Quad4 Deflation remains our call for Q4 – this is much more dangerous to carry trading and commodity price linked equity and debt markets than ebola headlines; intermediate-term risk range for WTI crude is $64.67-86.11 and 26% of the High Yield market is energy related (vs. 10% ten years ago); we held a very bearish call on MLPs yesterday.

RUSSIA

Got burning oil petro-dollar risk? Putin does – Russian stocks leading losers this morning, down another -1.6% and continuing to crash at -25.8% year-to-date – will the Russian economy crash? There’s a good case to be made that that’s already happening.

EUROPE

Hope that German manufacturing PMI being better than horrible (51.8 vs 49.9 last month) is just that – headline hope; German Services PMI slowed to 54.7 vs 55.7 and places like France had a train wreck manufacturing PMI print of 47.3 anyway. Reiterating short European Equities, across the board on #EuropeSlowing.

Asset Allocation

CASH 66% US EQUITIES 0%
INTL EQUITIES 0% COMMODITIES 4%
FIXED INCOME 26% INTL CURRENCIES 4%

Top Long Ideas

Company Ticker Sector Duration
EDV

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). U.S. real GDP growth is unlikely to come in anywhere in the area code of consensus projections of 3-plus percent. And it is becoming clear to us that market participants are interpreting the Fed’s dovish shift as signaling cause for concern with respect to the growth outlook. We remain on other side of Consensus Macro positions (bearish on Oil, bullish on Treasuries, bearish on SPX) and still have high conviction in our biggest macro call of 2014 - that U.S. growth would slow and bond yields fall in kind.

TLT

We continue to think long-term interest rates are headed in the direction of both reported growth and growth expectations – i.e. lower. In light of that, we encourage you to remain long of the long bond. The performance divergence between Treasuries, stocks and commodities should continue to widen over the next two to three months. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove. We certainly hope you had the Long Bond (TLT) on versus the Russell 2000 (short side) as the performance divergence in being long #GrowthSlowing hit its widest for 2014 YTD (ex-reinvesting interest).

RH

Restoration Hardware remains our Retail Team’s highest-conviction long idea. We think that most parts of the thesis are at least acknowledged by the market (category growth, real estate expansion), but people are absolutely missing how all the pieces are coming together to drive such outsized earnings growth over an extremely long duration. The punchline of our real estate analysis is that a) RH stores could get far bigger than even the RH bulls seem to think, b) Aside from reconfiguring 66 existing markets, there’s another 19 markets we identified where the spending rate on home furnishings by people making over $100k in income suggests that RH should expand to these markets with Design Galleries, and c) the availability and economics on large properties for all these markets are far better than people think. The consensus is looking for long-term earnings growth of 28% -- we’re looking for 45%.  

Three for the Road

TWEET OF THE DAY

Good top line from $UA. But only 21% EPS growth on 30% revs and just a penny beat might not be enough for a 57x p/e. SG&A up 39% -- big.

@HedgeyeRetail

QUOTE OF THE DAY

The more I practice, the luckier I get. 

-Jerry Barber

STAT OF THE DAY

Japanese Nikkei is down -0.4% to -5.7% year-to-date and remains bearish TREND on Hedgeye quantitative signals.



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Don't Be Intimidated

“We will not be intimidated.”

-Stephen Harper

 

I drove up to Maine in the rain yesterday. My ride was a metaphor for macro markets in the last six weeks. I got in the car in the late morning – equities were up, on decelerating volume. There was a faint bid to European equities and Oil. There was some low-conviction selling in the bond market too.

 

“So”… I did the opposite (in Real Time Alerts) – going right back to our #Quad4 playbook, sending out buy signals in Munis (MUB) and sell signals in stocks with energy price related risks (MLPs like Linn Energy, LNCO). #Bubbles that bounce to lower-highs on no volume don’t intimidate me.

 

As I drove through New Hampshire in the early afternoon, the US equity markets picked up on the intraday drop in oil prices – and bonds caught a bid. I flipped through a few of the manic media’s channels – they all blamed Canada.

 

Don't Be Intimidated - EL chart 2

 

Back to the Global Macro Grind

 

While it would be nice if we could boil down intraday, weekly, and monthly macro market moves to a single factor like ebola or Canada, that is not how a non-linear and interconnected ecosystem (the market) works.

 

That’s why we spend so much time grinding through both multi-factor and multi-duration analysis. We will not write to you about risks in the rear-view. We will not be whipped around by newsy headlines either. Our Global Macro risk management process will not be intimidated.

 

There’s a great complexity theory quote in the WWII #history book I am in the middle of reading that summarizes how the American, British, and Canadian men acted when storming the beaches of Normandy on June 6th, 1944:

 

“Beset by mischance, confounded by disorder, they had mostly done what they were asked to do.”

-Rick Atkinson, The Guns At Last Light (pg 53)

 

And while I try to not feel anything when communicating #timing decisions in markets, I do want our analytical troops to feel confident that, instead of being glued to the screens and emotions of the moment, they can do what they were trained to do. #Process

 

To be clear, the process is dynamic and flexible. That means that if the economic facts and/or market read-throughs change, we are both equipped and tasked to change alongside those changing factors. If they don’t change, we double down on the #process.

 

In asset allocation terms, here’s what we did (before the morning part of that drive!) yesterday:

 

  1. CASH – took it down small, deploying assets to a region of the market that likes #Quad4 (Municipal Bonds – MUB)
  2. FIXED INCOME – took it up, in kind, to a 26% allocation (which is 78% of what I consider my max, 33%, to any asset class)
  3. EQUITIES – stayed the course with the “net zero” exposure, adding to the bear side of energy related shorts like LNCO

 

For those of you who are new to reading my rants, the Hedgeye Asset Allocation Model is basically like my p.a. (personal account). It’s not what a long-only fund with a mandate to be fully invested has to do. It’s not a hedge fund either. It’s simply what I would do with my money - not being intimidated!

 

“So”, when I say “net zero” that means that if I had to be in something like US Equities, at a minimum, I’d hedge (with alpha oriented shorts) out the market risk and have a beta-adjusted net exposure to that asset class of 0%.

 

That’s why, on the morning of October 17th, in the Early Look you saw an asset allocation to US Equities of +3%. After a stiff selloff, I signaled “buy” in #RealTimeAlerts in 1 of the 2 S&P Sectors that are LONGS in our #Quad4 playbook – Consumer Staples (XLP). Then I took us back to net zero, on the bounce.

 

I know. It’s not easy trying to communicate a process that the Old Wall doesn’t use.

 

Commercializing how I think about risk has been as much a communication learning process for me as it has been for those of you trying to learn it alongside me. I appreciate your open-mindedness. These are still the early days of our changing parts of a profession that needs changing.

 

Back to what is really crushing market expectations (it’s not Canada – it’s #Quad4 deflation):

 

  1. Oil prices got smoked for another -2.8% loss yesterday, taking WTI to down -18.2% YTD
  2. Bullish to Bearish Phase Transitions in both Energy prices and their related stocks/bonds is #on because Oil is crashing
  3. Alongside a -25% drop in WTI Crude since June, the Russian stock market has crashed (-25.8% YTD)

 

That’s also why the Canadian Stock Market (TSX) went from bullish to bearish TREND @Hedgeye. Not because some whacko loser started killing people in Ottawa yesterday. In chaos (or complexity theory) speak, that was simply the grain of sand that knocked over the interconnected sand-pile.

 

In our playbook, terrorism doesn’t have a quadrant; #deflation does. If our quantitative signal is right, and the price of oil remains in an intermediate-term TREND risk range of $64.67-86.11:

 

  1. Both Oil & Gas (XOP) and Energy (XLE) related equities are going to be bearish TREND
  2. MLP related stocks and bonds are going to start discounting distribution (dividend) cuts
  3. Kevin “The Bear” Kaiser is going to look really right on his Best Short Ideas!

 

Instead of listening to more than 3 minutes of market spew on the radio yesterday, on that same drive up to Maine’s coast, I smoked  a cigar (don’t tell my wife!) and listened to Kaiser’s Institutional Research call on MLPs from 1-2PM. It was awesome.

 

And I’m not just saying that because the man is on my team. I am telling you what it is to hear a world class analyst not be intimidated by institutional group-think and stay with a fundamental call that companies who don’t have the cash flow to pay out future promises are shorts.

 

Stocks that he doesn’t like (VNR, LNCO, etc.) got hammered intraday. If you’d like access to the replay of his call and 40 slide deck, please ping .

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.09-2.34%

SPX 1

RUT 1037-1119

VIX 15.09-28.26

WTI Oil 79.43-82.63

Natural Gas 3.59-3.79

 

Best of luck out there today,

KM

 

Don't Be Intimidated - Chart of the Day


THE HEDGEYE MACRO PLAYBOOK

Takeaway: Our Macro Playbook is a daily 1-page summary of our core ETF recommendations, investment themes and proprietary quantitative market context.

CLICK HERE to view the document. In today’s edition, we highlight:

 

  1. How our Tactical Asset Class Rotation Model (TACRM) quantitatively combines Complexity Theory,  technical analysis and Behavioral Economics into unparalleled global financial market color and how we use that color to make informed risk management decisions
  2. How today's broad-based, global asset price deflation is similar to the setup that precipitated QE3 and why QE4 has be the bull case for anyone grossing up their exposure to risk assets here
  3. Why we think the bounce is Homebuilder stocks (via the ITB) is very shortable

 

Best of luck out there,

 

Darius Dale

Associate: Macro Team


Biting the Hand That Feeds

This note was originally published at 8am on October 09, 2014 for Hedgeye subscribers.

“If I were investing in oil and gas stocks, there is one question I would ask CEO’s: what portion of your capital is going to have to go in to stay even?”

-Gwyn Morgan, Former CEO of EnCana, 2002

 

Shale Gas now accounts for 40% of all U.S. natural gas produced, with its share expected to increase to 53% by 2040 according to EIA estimates. The U.S. has approximately 31 years of current aggregate domestic natural gas production in technically recoverable shale reserves (assuming all natural gas produced is from shale: ~60 years of recoverable reserves at peak estimated production levels).

 

The Bureau of Labor Statistics (BLS) recently reported that the largest employment increases since the shale revolution commenced circa 2006 have occurred in the four U.S. states which just so happened to have engaged in the heaviest amount of hydraulic fracturing: North Dakota, Louisiana, Oklahoma, and Texas.


Although an increase in overall drilling has ceased, the production of natural gas has increased dramatically. Companies can produce 6x the amount of natural gas they could from the same well in 2010. Smarter, more efficient drilling and better technology have contributed to the increase in well productivity in the last few years.

 

Many domestic industries benefit from the increase in U.S. natural gas production from the petrochemicals and fertilizers space to the iron, steel, and glass manufacturing players. With an abundance of this resource seemingly available at what should be cheap prices for years to come, why not take advantage?

  • Collectively embrace new projects
  • Quickly approve LNG Export terminals to help both domestic producers and the trade balance
  • Build an interconnected domestic network of pipelines

Biting the Hand That Feeds - 16

 

Why bite the hand that feeds?


Back to the Global Macro Grind…


Just to (again) re-iterate our preferred #QUAD4 positioning (GROWTH SLOWING, INFLATION DECELERATING):

  • We still like bonds (treasuries and munis)
  • We still think growth and inflation are slowing in the U.S.
  • We still have no evidence to suggest the monetary policy response in #Quad4 is anything but dovish

We outlined the outlook for the domestic economy in a #QUAD4 scenario in our macro themes call last week (ping sales@hedgeye.com for replay access).

 

If there was any question about the Fed-fueled leverage embedded in overall market levels, Janet Yellen’s dovish commentary that lifted the S&P 500 44 handles off the lows to close on the highs of the day should give some insight as to why the economy and the stock market become diverged (even for long periods of time)… UNTIL IT ENDS.

 

The global economy was cited as “weaker than anticipated” yesterday and the stock market rallied +2.3% off the lows.

 

The release of the Fed minutes from the September 16-17 meeting revealed that committee members were worried that:

 

“further gains in the dollar could hurt exports and damp inflation”

  • The S&P 500 airlifted off the lows to close +1.7% d/d
  • The 10-Yr yield backed up for the fourth consecutive day and is now at a new YTD LOW (2.28%) with every tick
  • The USD retreated 44 bps (RED AGAIN THIS MORNING)
  • Gold is ripping this morning on the follow through (+1.6%)

 

Why not just buy stocks and let the Fed have their “Free Lunch” as my colleague Christian Drake explained in Tuesday’s Early Look?  Why complain? Why bite the hand that feeds?


While the Fed can admittedly talk the currency in either direction, a #QUAD4 scenario also implies the existence of deflationary headwinds in the commodity space.  

 

The answer to Gwyn Morgan’s aforementioned quote is difficult to answer at the beginning of a project.

 

Which E&P projects are NPV positive? How can we possibly know?


With so much uncertainty in energy prices years into the future, this question is often left unanswered until it’s boom or bust. Energy companies certainly don’t like the disinflation of prices since mid-summer.

 

As you can see in today’s chart, the Thomson Reuters Wildcatter’s Index (small and mid-cap E&Ps) has retreated -33% from its June YTD highs. If you top-ticked that move, it was the same day you shorted oil at the 2014 highs. 

 

The steep premiums for natural gas in some parts of the United States shed light on the capital intensive nature of investing in the re-birth of the North American energy boom fueled by evolutionary production of shale rock resources.

 

While the onsite production is ramping-up across the country and flooding the market with supply, refining and transportation availability is still lacking, causing large premiums in those regions where it’s difficult to distribute resources. Developing the infrastructure requires time, and the profitability of each project is at the mercy of unpredictable oil and gas prices.


Marginal production costs in the Utica and Marcellus regions in Ohio, Pennsylvania, and West Virginia are as low as anywhere in the country. Yet, natural gas futures for January delivery in New England are priced $15 (highest nationally). If a producer in Utica could produce and refine for, call it $3, the spread is $12, so why not build a pipeline? Assume a pipeline was built from Harrison, WV to Boston (656 miles) at $3M/MILE (low-end of the cost structure).  The all in cost is approximately $2Bn.

 

While it’s easy to field one side of the argument to produce more oil and gas, create jobs, and export the extra supply (amidst a global slowdown), lower prices are squeezing domestic producers. With the lever-up, invest now-benefit later nature of the business, the most- sound companies who have picked the best projects to undertake will be able to withstand a further sell-off in oil and gas prices.

 

Rankings of Marginal Production Costs of U.S. Shale Plays (Lowest to Highest):

  1. Utica
  2. Southwest Marcellus
  3. Permian
  4. Northeast Marcellus
  5. Eagle Ford
  6. Granite Wash
  7. Niobrara
  8. Barnett
  9. Haynesville

Rankings of Natural Gas Production per New Rig (Highest to Lowest):

  1. Marcellus
  2. Haynesville
  3. Utica
  4. Niobrara
  5. Eagle Ford
  6. Bakken
  7. Permian

  

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.30-2.45%

SPX 1930-1975

RUT 1072-1123

DAX 8938-9317

VIX 14.16-17.58

USD 85.01-85.99

EUR/USD 1.26-1.28

Pound 1.60-1.62

WTI Oil 86.82-93.17

Nat. Gas 3.81-4.05

Gold 1195-1235

Copper 2.98-3.07

 

Ben Ryan

Analyst

 

Biting the Hand That Feeds - 10.09.14 Wildcatters Index

 


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