Yelp's IPO may end up yelping

November 29, 2011: 10:36 AM ET

It may be easy to read too much into declines at Groupon, Pandora and LinkedIn. But Yelp is facing strong headwinds that could spell trouble.

By Kevin Kelleher, contributor

FORTUNE -- Unlike Yelp the company, "yelp" the word dates back to the 1500's, when its original meaning was "boasting". Over the years, it came to mean something quite different: "A short, sharp cry, especially of pain or alarm" as the Concise OED puts it.

That downward trajectory seems to be playing out over a much shorter time span as Yelp the company gets ready to go public. Founded in 2004, Yelp soon sprinted past Citysearch as the premier site for customer reviews of restaurants and local businesses. The company reportedly spurned a $500 million offer from Google (GOOG), only to file for an IPO that could value the company at $2 billion. That wold give Yelp a lot to boast about.

But that outcome may be derailed by a turbulent stock market and a growing sense among investors that the IPOs of young social-web startups may not be such hot investments after all. Groupon (GRPN), the leader in the group buying market, and Angie's List (ANGI), another user-review site that recently went public, fell last week, suggesting the appetite for tech IPOs may be waning. (Facebook, which may be targeting and April 2012 IPO, is in a category by itself.)

In the three and a half days of trading last week, Groupon's stock fell 36% to $16.75, well below its $20 offering price. Angie's List fell 15% to $13.50, or 50 cents above its Nov. 16 offering price. Other IPOs in the class of 2011 fared poorly as Pandora (P) stock fell 16% and LinkedIn (LNKD) dropped 12%. The Nasdaq Composite, by contrast, declined 5% in a market jittery about the financial turmoil in Europe.

It can be easy to read too much into these declines. After all, trading was light ahead of last week's Thanksgiving holiday, adding to volatility. And Groupon, an sudden favorite of short sellers, is looking to be an especially volatile stock. If things settle down in Europe, or if another web IPO -- say, Zynga -- has a strong debut soon, last week's gloom could be seen as a brief aberration in the IPO market.

And in some ways, Yelp seems quite different from Groupon. Its IPO has received a moderate amount of coverage, while Groupon's was the subject of a passionate debate for months. Groupon feels like an eBay-like (EBAY) trend waiting to peter out. Yelp is more of a steady resource that could last for many years. While Groupon invested up front to grow quickly in a couple of years, Yelp nurtured its growth slowly.

Here's an archive of Yelp's site six years ago. It looks much the same, only with a few thousand reviews. Today, Yelp has 22 million reviews, but it's taken several years to grow that big, focusing on the experience for users and restaurants rather than spectacular metrics. This is not a company in a rush to cash out.

But a closer look at Yelp's IPO prospectus shows the company looks more Groupon-y than many investors would be comfortable with. For one thing, Yelp has consistently posted a loss. In the first nine months of 2011, it showed an operating loss of $7.4 million, equal to 15% of its $40.3 million revenue in that period. To date, Yelp has accumulated $32 million in losses. (Zynga, by contrast had a 10% operating margin in the first nine months of 2011.)

Slowing revenue growth, one of Groupon's recent concerns, isn't afflicting Yelp so much. In 2009, Yelp's revenue grew by 113%. In 2010, the growth rate slowed somewhat to 85% but held steady at 80% for the first nine months of 2011. Yelp's most recent quarter saw revenue grow 18% from the previous quarter, compared with a 9% growth rate for Groupon. Although Yelp is older than Groupon, it's growing twice as fast sequentially.

Still, Yelp faces some problems that Groupon doesn't. For one, its operating costs are rising. Yelp's sales and marketing costs were equal to 67% of its revenue last quarter, up from 63% in the previous quarter. Similarly, product-development costs rose to 16% of revenue from 14% and administrative costs rose to 21% from 18%.

Even more alarming, Yelp has yet to generate cash flows. Its operations aren't yet financing themselves. Cash flows from operations were a negative $296,000 in the first nine months of 2011, although that figure was down from negative $6.4 million a year earlier. While Groupon has been cash-flow positive since 2009, Yelp's operations appear to be burning through cash even as it's going public.

Yelp is a popular and growing startup that needs to raise capital to finance its future growth. Unfortunately, its years of losses and historical inability to generate cash from operations suggest the IPO is being rushed. That's too bad for the company, given the recent sense of disenchantment with money-losing web IPOs.

For some time, the promise of the social web made companies like LinkedIn and Yelp seem like investor safe havens in an uncertain economy. But maybe not anymore. A profitable company like Zynga could still receive a warm welcome in the IPO market. But weaker companies are likely to get kicked around. The yelps that result won't be happy ones.

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