When Yelp (NYSE: YELP) announced strong quarterly results last month -- posting higher-than-expected revenue and narrowing its per-share losses -- it seemed strange at first to see shares of the local business review website fall almost 8% in response.
Though shares attempted to bounce back in the days following that drop, Yelp has steadily drifted downward in recent weeks as multiple analysts have stepped out to downgrade the stock.
Let's take a closer look, then, at what has spurred this wave of negative sentiment -- and more importantly, whether it's truly merited.
IMAGE SOURCE: YELP.
Why Wall Street hates Yelp...
On one hand, Yelp's impressive quarter primarily stemmed from accelerating advertising revenue growth; ad sales climbed 20% year over year to $214 million, comprising the vast majority of Yelp's top line.
On the other hand, that acceleration came primarily as Yelp rolled out a more flexible, non-term advertising product, which effectively encouraged a record number of new advertisers to try out the platform without the risk of being tied into longer-term contracts. However, this seeming lack of commitment from advertisers leaves many on Wall Street skeptical of whether Yelp's recent strength will be sustainable.
...and why investors should love it
I think that skepticism could be misplaced.
For one, Yelp has insisted the move was carefully tested, planned, and implemented. According to Yelp Chief Operating Officer Jed Nachman during their most recent earnings call, these non-term contracts have "become more of the norm" as enabled with the rise of digital ad giants like Facebook and Alphabet 's Google. To that end, failing to evolve with a changing market would have been a terrible mistake for Yelp.
The overall goal of non-term contract is to really reduce the friction in the buying process, open up the acquisition funnel and ultimately have a positive net effect on rep productivity. [...] We've been testing this model for close to two years now with a small group of reps and really started to accelerate that in Q3 and Q4 of last year. By the end of 2017, we had transitioned about 40% of the sales force to the non-term contract model. And by the end of Q1, we had close to 75%.
What's more, not only have a record number of newer advertisers come aboard -- some on a trial basis, and some with more seasonal purchasing -- but its existing base of loyal long-term customers are also still buying under the new model.
Regarding the former, Nachman added:
These customers not only provide additional revenue in the short term, but are also activated into the Yelp ecosystem where we can really actively market to them and take friction out of those folks, reactivating into an advertising program.
Still, it's hard to blame investors for their nervousness given the change. But as Yelp continues to transition its sales force to non-term contracts, I think chances are high that its revenue growth in the coming quarters will prove sustainable as it grabs the low-hanging fruit offered by customers outside of its core base. If that happens, the stock's recent pullback could prove to be a golden chance for Yelp investors to open or add to their positions.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Steve Symington has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A and C shares), and Facebook. The Motley Fool recommends Yelp. The Motley Fool has a disclosure policy .