Yelp Inc.: (NYSE: YELP) Soars in Early Trading – But Is it a "Buy"?

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Online review site Yelp Inc. (NYSE: YELP) joined the Internet IPO craze when it started trading today (Friday) – and soared more than 60% in its first hour of trading.

Yelp is one of the largest business search/rating sites. It allows users to search for local businesses and read reviews and opinions written by contributors.

Yelp priced its IPO late Thursday at $15 a share, above analyst expectations of $12 to $14. That gives the U.S. consumer rating site a $900 million value. The company offered 7.1 million shares, raising $106.5 million.

Yelp could be the last Internet IPO until Facebook's long awaited debut later this year. It faces the same concerns as its predecessors – can it live up to its valuation and turn a profit for investors?

So far it seems the biggest winners will be those profiting from Yelp's first-day pop. But the long-term threats to Yelp's profitability could cool today's frenzy.

Here's what investors should consider before trying to cash in on Yelp.

Buy Yelp Inc. (NYSE: YELP)?

Yelp overview: San Francisco-based Yelp for the year ended December 31, 2011 saw revenue jump 74% to $83.3 million, but recorded a loss of about $17 million. That's up from a $9.6 million loss in 2010. It also has accumulated debt of about $41.2 million since it began in 2004.

Yelp doesn't focus on just one business sector – although about 42% of the reviews on the site are dining-service related – which could help it excel more than Angie's List Inc. (Nasdaq: ANGI), which has a niche in service-related companies.

Yelp has invested in improving credibility by policing fake reviews and making efforts to favor the site user, not the merchants.

Yelp's problem thought is that it needs to attract both consumers and businesses but is making substantially more money from businesses. Industry insiders say Yelp needs a solid plan for growth that doesn't rely solely on merchant ads, in order to limit its yearly losses and reduce its debt.

"Sites like Yelp need to deal with a fundamental question: Who is the primary constituency? Is it the users, reviewers, or the merchants?" Mitch Rothschild, CEO of doctor review site Vitals, told Forbes. "The challenge with businesses like Yelp is that the users don't pay the company – but the company needs their loyalty. So how big Yelp gets will depend on whether it can iterate new revenue streams…Pure merchant advertising will not likely fuel adequate long-term growth."

Yelp profitability: Yelp has about 66 million monthly unique visitors, and 25 million reviews posted online now, and operates in 46 U.S. markets and 25 international markets. It also has a popular mobile app.

The company generates about 40% of revenue from display ads. Most of that is from advertising sales by merchants who are reviewed. It also makes money from subscriptions and additional services like deals and partnerships with Open Table Inc. (Nasdaq: OPEN).

But Yelp does have high marketing and sales costs. The percentage of those costs compared to net revenue has declined, but still eats away at profits.

Yelp made more money than many expected with its IPO – but for long-term investors, it hasn't proven there's a strong business model.

"Yelp…will be one of the more successful IPOs of the year," Payam Zamani, CEO of Reply.com, told Forbes. "But as they further make progress, they will need to implement a much more scalable path for revenue growth instead of deploying thousands of sales people all over the country. The current approach for signing up local advertisers is simply too linear and does not benefit from the power of the new media…"

Yelp competition: Larger tech companies like giant Google Inc. (Nasdaq: GOOG) feature their own consumer reviews. Google accounted for more than half of Yelp's site traffic in 2011, but since GOOG started a competing service it removed some links to Yelp from its search engine.

Without Google's search engine power, Yelp traffic and visibility could permanently shrink. Yelp in its prospectus listed Google's delinking actions as a red flag.

Angie's List and Foursquare also are gunning for the same consumer-review market as Yelp, and Facebook Inc. could steal its ad revenue.

"We are encouraged by trends in Yelp's traffic growth and customer reviews of local businesses, but it is too early to declare the company a winner in the market for local advertising," Morningstar analyst Rick Summer wrote in a research note this week.

First-day trading: Yelp is expected to pop today just like Groupon Inc. (Nasdaq: GRPN) and Angie's List, which rose 30% and 25% in their first days, respectively. Groupon now trades about even with its $20 IPO price, and Angie's List has climbed 24% since it started trading in mid-November.

By late morning trading Yelp was on track to beat the first-day performance of fellow Internet IPOs, already netting first day gains of more than 60%.

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