Takeaway: Management and the sell-side are looking to poke holes in our thesis. There is one question that will settle the debate.
- PUSHBACK vs. REALITY: Management and the sell-side are trying to push back on our thesis. Below is a summary of what we've heard, and our response with incremental data and analysis addressing each counterpoint. Please let us know what other pushback your're hearing so we can address that as well.
SUPPORTING CHARTS & ANALYSIS: The initial version of this note was too long, so we cropped it, attempting to keep it text-light and chart-heavy. Happy to send over additional analysis or discuss in more detail.
THE ONE QUESTION THAT MATTERS: The only way management can settle the debate is by answering one question: "What percentage of your current customers have been advertising and/or generating revenue for YELP for more than a year?" Everything else is just noise.
PUSHBACK vs. Reality
Not surprisingly, management and the sell-side pushing back on our thesis; mostly through attacking the messenger, rather than the thesis itself (i.e. ad hominem). Below is a summary response to each attempted rebuttal, with supporting details in the next section.
- CAN'T CALCULATE ATTRITION RATE?: from the customer repeat rate. This is all about the language. When management says this, they are referring to calculating the annual rate from the quarterly customer repeat rate, they're not saying that we can't calculate the quarterly rate, nor does it address absolute levels of attrition.
- EFFECTIVE SALESFORCE? The pushback is that if YELP is having heightened attrition issues, it must have a very effective salesforce to compensate. The reality is the exact opposite. YELP's salesforce has been growing ~50% y/y each of at least the last 8 quarters. We estimate that its salesforce would be wildly unproductive if YELP wasn't having these attrition issues (i.e. unprofitable).
- COHORT GROWTH TOO STRONG: The pushback is that the strong growth in its early cohorts wouldn't be possible if YELP was having heightened attrition issues. The reality is that ~50% of US Businesses reside in these cohorts, and YELP was very slow to penetrate these cohorts in terms of both Claimed & Active Businesses.
- OTHER SERVICES SKEWING METRICS: The pushback is that customer repeat rate could be distorted in any one period from accounts intermittently deploying deals & gift certificates. The reality is that argument doesn't consider customer overlap. Regardless, quarterly fluctuations across less than 5% of its revenues don't matter; especially since its attrition issues are a recurring quarterly theme.
SUPPORTING CHARTS & ANALYSIS
Can't Calculate Attrition Rates?: There is no debating the quarterly attrition rates, or the magnitude of new and lost accounts. We can't calculate the exact annual rate, but that is function of the source of those lost accounts (prior vs. new customers), not whether YELP is actually losing them. Most advertising customers sign annual contracts, meaning most of its new business can't be lost within a year (without paying 2-3 month penalty). So the bulk of those lost accounts are coming from existing accounts signed before the most recent LTM period. Comparing cumulative lost accounts to prior-year period accounts, and cumulative new accounts to current period accounts, tells the story.
Effective Salesforce: The chart below measures New Revenue/Rep:
(New Accounts x YELP stated ARPU)/Trailing Sales Reps. The Reps are lagged on a 9-month basis (so any hires during the quarter or in the 6 months prior are assumed to generate no revenue). The difference in the two metrics below is our calculation for new revenue vs. what is implied by account growth in YELP's reported metrics; the latter suggests its salesforce isn't generating enough new business to cover their own salaries (note: this is base only, not inclusive of ancillary employment costs).
Cohort Growth: YELP had been slow to penetrate this segment, with only ~300 claimed businesses at the end of 2010 out of the total pool of at least 1.9M potential businesses in these cohorts. In short, most of the early cohort wasn't even on YELP by the end of 2010. Cohort growth remains strong because YELP didn't meaningfully penetrate this group until it started ramping its salesforce. Since 50% of US businesses reside in these early cohorts, we expect YELP will see decelerating growth in the later cohorts first given that included markets are relatively smaller.
Other Services Skewing Results: The pushback doesn't assume customer overlap between Local Advertising and Other Services (e.g. a customer could could stop offering a deal, but still advertise with YELP). Even if there weren't any overlap, Deals/Gift Certificates are less than 5% of revenue, so how much of an impact could these fluctuations in these services make on the overall quarterly attrition trend? Regardless, the attrition trend is too consistent for this argument to hold any water.
THE ONLY QUESTION THAT MATTERS
"What percentage of your current customers have been advertising and/or generating revenue for YELP for more than a year"
Answering this question will settle the debate, and is the only way that management can refute our analysis, or make any claims that it is not experiencing heightened attrition.
This question is basically a derivative of its customer repeat rate metric, so the only reason management would avoid the question is if they have something to hide.
We asked YELP's CFO this question, and didn't get an answer: YELP: Chat with the CFO (Recap). So if you have a line into management, see what they say. If you happen to get a number or a ballpark figure, let us know, and we'll let you know if the math makes sense.
The key to answer the answering this question will come from YELP's customers, not management. In this regard, stay tuned.
RISK TO OUR CALL
In light of M&A activity heating up, this remains the key risk to our call. A recent rumor suggests a major player is looking at YELP. While possible, we think it unlikely once the potential acquirer gets a look at their financials.
Management and the sell-side will try to spin the story any way they can to avoid addressing the core issues. Collectively, we haven't heard anything remotely close to a credible rebuttal to our thesis. But please, let us know what other pushback you're hearing so we can address that too. Truth be told, we're having some fun with this.
Hesham Shaaban, CFA
Client Talking Points
Another no volume rally on our hands – Total US Equity Volume yesterday was down -14% and 34%, respectively, compared to its one- and three-month averages.
Meanwhile, the 2.47% yield on the 10-year continues to signal that real-world inflation is slowing US consumption growth. The CRB Commodities Index (19 commodities) is up +10% year-to-date compared to US Growth (Russell), which is down -2.1%.
In Asia, it was a wet Kleenex response to that no-volume US rally overnight. South Korea was down -0.9% and Indonesia was down -1.8%. In Japan, the Nikkei fell another 0.3% after failing the TREND resist (again) and is now down -9.4% year-to-date.
|FIXED INCOME||24%||INTL CURRENCIES||23%|
Top Long Ideas
Hologic is emerging from an extremely tough period which has left investors wary of further missteps. In our view, Hologic and its new management are set to show solid growth over the next several years. We have built two survey tools to track and forecast the two critical elements that will drive this acceleration. The first survey tool measures 3-D Mammography placements every month. Recently we have detected acceleration in month over month placements. When Hologic finally receives a reimbursement code from Medicare, placements will accelerate further, perhaps even sooner. With our survey, we'll see it real time. In addition to our mammography survey. We've been running a monthly survey of OB/GYNs asking them questions to help us forecast the rest of Hologic's businesses, some of which have been faced with significant headwinds. Based on our survey, we think those headwinds are fading. If the Affordable Care Act actually manages to reduce the number of uninsured, Hologic is one of the best positioned companies.
Construction activity remains cyclically depressed, but has likely begun the long process of recovery. A large multi-year rebound in construction should provide a tailwind to OC shares that the market appears to be underestimating. Both residential and nonresidential construction in the U.S. would need to roughly double to reach post-war demographic norms. As credit returns to the market and government funded construction begins to rebound, construction markets should make steady gains in coming years, quarterly weather aside, supporting OC’s revenue and capacity utilization.
Legg Mason reported its month ending asset-under-management for April at the beginning of the week with a very positive result in its fixed income segment. The firm cited “significant” bond inflows for the month which we calculated to be over $2.3 billion. To contextualize this inflow amount we note that the entire U.S. mutual fund industry had total bond fund inflows of just $8.4 billion in April according to the Investment Company Institute, which provides an indication of the strong win rate for Legg alone last month. We also point out on a forward looking basis that the emerging trends in the mutual fund marketplace are starting to favor fixed income which should translate into accelerating positive trends at leading bond fund managers. Fixed income inflow is outpacing equities thus far in the second quarter of 2014 for the first time in 9 months which reflects the emerging defensive nature of global markets which is a good environment for leading fixed income houses including Legg Mason.
Three for the Road
TWEET OF THE DAY
Some days I feel like it’s still the 16th century – no enlightenment. @KeithMcCullough
QUOTE OF THE DAY
"The best way to have a good idea is to have lots of ideas." - Linus Pauling
STAT OF THE DAY
Australian recording artist Iggy Azalea has scored both the number one and two spots in the US Billboard Hot 100 chart, a feat achieved only once before – by The Beatles. (The Telegraph)
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“To you from failing hands we throw. The torch; be yours to hold it high.”
-Dr. John McCrae
On Tuesday night I had the pleasure of attending my first hockey game at the Molson Center in Montreal. While I’m not necessarily a Habs fan, sitting in a seat on ice level next to the penalty box is definitely the right way to watch playoff hockey in Canada, especially in a 7 - 4 “Wild West” shoot out.
Last night, of course, was much different. The New York Rangers and their all-world goalie Henrik Lundqvist bounced back and New York beat Montreal to advance on to a date with destiny and a chance to win Lord Stanley’s Cup.
The last time the New York Rangers won the Stanley Cup was in 1994, exactly twenty years ago. The last time a Canadian team won a Stanley Cup was actually twenty-one years ago in 1993 when Montreal won. So if you do the math, in the last twenty years a Canadian team has won the Cup about 5% of the time. This comes despite the fact that 24% of the teams in the NHL are based in Canada.
Interestingly, statistician Nate Silver from ESPN actually ran the numbers on the probability of a Canadian winning the Cup over that period. According to Silver:
“If a championship team was randomly chosen for each of the 19 seasons the league actually played, the odds of a Cup win for a Canadian team would have been 99.2 per cent. Taking teams’ actual competitiveness into account, Silver estimated the odds of a Canadian win during that time period were 97.5 per cent.”
So, clearly next year is Canada’s year and this unfortunate run is just bad luck. But in the meantime, let’s go Rangers!
Back to the Global Macro Grind . . .
Despite the fanfare for the Ranges in the Big Apple last night, shockingly enough, the global macro markets didn’t react. The biggest laggard in terms of major equity markets overnight is actually Korea, which is down about 85 basis points. Even there, though, there is not much of a read through other than some profit taking ahead of the Dragon Boat Festival on Monday. (Is your dragon boat ready?)
The takeaway more broadly, of course, is that a general complacency is setting in on global markets. Two import signals of complacency are the VIX, which measures volatility on U.S. equities, and yields on peripheral sovereign debt in Europe. In both instances, they are literally at five year lows.
For those of you that are used to winning investing performance Stanley Cups, you get the joke. Either things are that good and there is nothing to worry about, or they are not and it is time to throw some proverbial caution to the wind by getting shorter and/or selling exposure.
On the risk front, a major concern we continue to have is that consensus is once again over estimating the potential for U.S. economic growth in the U.S. For the U.S. to hit consensus GDP growth estimates for the rest of the year, economic growth will have to come in at 4% in aggregate for the next three quarters. To state the obvious: that’s not happening folks.
My colleague Christian Drake view of Q1 GDP is as follows:
- Bad But Not A Surprise: The first revision to 1Q14 GDP came in at -1.0%, missing estimates of -0.5%. The magnitude of the revision was larger than expected but the negative print and downward revisions to inventories, exports, & Gov’t spending was not a surprise as the actual march data came in worse than the BEA estimates embedded in the advance GDP report.
- Inventory Drag: The negative revision to inventories was the biggest contributor to the total revision. The inventory ramp, which comprised a big portion of reported nominal GDP growth in 2H13, is now reversing as end demand/income growth proved insufficient at expeditiously drawing down that burgeoning stock.
- Consumption: Strength in consumption growth, particularly Services, was the conspicuous positive on the quarter. Notably, Services consumption was supported by the significant acceleration in healthcare spending.
Healthcare is indeed the juggernaut of GDP and something to focus on, at least in the reported numbers. As Christian points on healthcare spending in the GDP report:
Healthcare Spending: The strength in Healthcare Services spending stems largely from the implementation of Obamacare. The reported figures, by BEA’s own admission (see their note Here), are very much an estimate and the preliminary data are likely to be revised (significantly) over time as the Census bureau’s quarterly QSS and annual SAS survey’s provide harder data.
With reported Hospital and Outpatient spending both accelerating materially in 1Q14, it could also be that individuals are accelerating medical consumption ahead of ACA implementation and uncertainty around coverage changes.
Either way, in the context of the broader spending data, the takeaway is pretty straightforward – Healthcare Services represent ~17% of total household consumption expenditures and certainly impacts the direction of reported, headline consumption growth. To the extent that deceleration is the larger trend across the balance of services, a mis-estimation of ACA related spending and/or a significant, transient pull-forward in medical consumption could be materially distorting the prevailing, underlying trend.
Unfortunately, we’ll just have to hurry up and wait to get a clearer read on the magnitude of the impact.”
So, even as the labor market is showing some tightening, in part aided by people dropping out of the work force, economic activity broadly speaking is far from robust and likely to miss consensus expectations for the remainder of the year, especially with the housing market headwind. And at a VIX of sub 12, bad news will start to matter.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.42-2.51%
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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