Why Short Sellers Were Wrong About Yelp

It was no surprise that traders bet against Yelp, Inc. in the days before the company released 52 million shares of stock. Just two weeks earlier, Facebook, Inc. stock fell to a record low as insiders dumped shares after the company’s first lockup period expired. Other tech companies like Groupon, Inc. and Angie’s List, Inc. also saw their stock fall when early investors were permitted to sell shares.

What left the market scratching its head was that Yelp didn’t follow in Facebook’s footsteps. Instead, its stock gained more than 20 percent, burning traders who tried to profit from falling prices.

These investors used a strategy called short selling. They borrowed shares of Yelp, expecting to buy them back cheap when the stock fell and booking a profit on the price difference. Instead, Yelp bucked the tech stock trend. Short sellers took a loss because they had to pay more for the stock when it came time to return the shares to the lender.

The consensus among most analysts is that these short sales accounted for higher performance in the post-lockup period. As it became clear that a selloff was not in the cards, investors scrambled to buy back shares before the price climbed even higher. The rush to buy pumped up Yelp’s stock.

So what did the pessimists miss when they shorted Yelp? A few things.

It’s the Shareholders, Stupid

Unlike Facebook and Groupon, the majority of Yelp’s shares are owned by venture capital firms rather than employees. These firms – which include Bessemer Venture Partners, Benchmark Capital, DAG Ventures and Elevation Partners – chose not to sell, and that kept stock prices stable.

Aaron Kessler, a senior research analyst at Raymond James Financial Inc. illuminated the importance of Yelp’s shareholder base in a recent Wall Street Journal article: “A lot of time you see employees selling early because they need the money quicker. But for VC’s and others, it’s not as meaningful for them.”

Positive Earnings

These venture capital firms may have been inspired to hold onto their stock by Yelp’s second quarter earnings report. As Danielle Kucera reported for Bloomberg, Yelp’s revenue rose 67 percent to $32.7 million. While the company registered a net loss of $1.98 million, analysts had projected larger losses.

Yelp also revised its guidance upwards. The company tacked another million onto earnings expectations for both the third quarter and 2012. That puts annual revenue growth at 63 percent above 2011, according to Yahoo Finance.

The Apple Advantage

If it’s been said once, it’s been said 100 times: mobile is the future. And Yelp’s future looks rosy. Apple Inc. recently announced that it will better integrate Yelp with its new iPhone operating system — music to investors’ ears.

When the iPhone 5 hits the shelves in the fall, users will be able to check in to locations on Apple’s new mapping software via Yelp. Earlier this year, Siri, Apple’s voice-activated assistant, began directing requests for nearby restaurants, retail shops, and entertainment venues to Yelp’s mobile app.

The Yelp squeeze suggests that investors might do well to think twice before putting a blanket bet against tech stocks.

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