Groupon's Pivots Won't Stop The Sinking

Nov.15.12 | About: Groupon, Inc. (GRPN)

Groupon (NASDAQ:GRPN) has continued its quick fall to the bottom this year as it has now lost over $20 on its share price and sits below the $3 mark. For many, this outcome has been long expected, as Groupon's fundamentals leave much to be desired. For the company to return to relevance it is pinning its hopes on becoming the "operating system of local commerce", although personally, I'm weary about its ability to make this move. Expect Groupon to find its equilibrium in a substantially smaller market capitalization with lower profitability.

First among the poor fundamentals is Groupon's bloated staff. Currently, it employs almost 11,500 employees. To be fair, the number of employees itself is a poor metric of success or failure, but the fact that Groupon's business relies on salespeople to push daily deals with little in the way of automation, signals that the company has little in the way of resilience. One point is that while the company continues to employ a substantial sales force, year on year sales are down about $430 million.

Much to its credit, the company is now beginning to use technology to replace and increase the productivity of its sales force. However, it recently cut only about 80 sales jobs, which is likely too low to make any significant difference.

But one should also question Groupon's main source of revenue: daily deals. The fact that it intends to pivot so drastically into becoming the operating system of local commerce is a negative indicator to investors. Established companies rarely pull off a successful pivot and it remains to be seen whether Groupon is an innovative enough company to pull it off. True, it did make one great innovation and that has kickstarted its progress, but it has failed to keep that innovation to itself. The market has been flooded with other companies offering the same deals as Groupon does. The transition away from this core service will be difficult, as will keeping others from following suit. Making the task even more difficult is the fact that Groupon has never been an impressive technological company so entering the software market is a larger change than most people might believe.

But the fact that daily deals are a fad that has failed to deliver is apparent to most and is the main reason that its revenue fell below both analysts' expectations and the company's own guidance.

Specifically, the company earned about $568 million in revenue, a lower than expected number which the company chalks up to economic sluggishness in Europe. Personally, I think that is far too rosy eyed. As I mentioned, revenue is down over $400 million and Groupon's European problem is certainly not the singular cause of that drop.

However, even despite these shortcomings, few analysts rate Groupon as a sell. Among 25 analysts, only three believe that Groupon is a sell, with seventeen rating it as a hold. This surprises me since the company's revenue streams are highly volatile and there doesn't seem to be an end in sight for the European crisis, suggesting its problem there will not improve anytime soon.

Additionally, the average price target for Groupon is about $7, which is still $13 below its January price. Having said that, current investors would be ecstatic if the price increased to $7.

But, as I mentioned earlier there are reasons to be bullish. The market for local commerce is huge and it remains an open market with just a few big names. Current players like Yelp (NYSE:YELP) and Foursquare are increasing their position in local commerce but have anything but a hold on these markets. Also, these companies are vying for a different segment of these markets and won't pose a threat if Groupon successfully implements its operating system.

And the company has taken some good steps towards creating this operating system. Just recently it acquired the point of sale company Breadcrumb and restaurant reservation company Savored. These are fantastic acquisitions that position the company as a service provider which should stabilize its revenues. It will be much easier to convince businesses that these services are value-added than Groupon's base service.

To be sure though, any entrance into the point of sale market faces stiff competition as services offered by Square continue to dominate. In fact, for the acquisition of Savored to work I think that it will need to be tied in to a slew of other services. Being second place in this particular market is a terrible position to be in.

Overall, I can't say that Groupon is a solid investment - even if it's able to hit a target price of $7, it'd be hard to stay propped up there with coupons chipping away at its market share. This is a highly risky stock that equally has potential to reinvent itself or fade into irrelevance. Much of this stock's riskiness comes from whether you believe in its new path or not.

Truthfully, I think Groupon waited too long - and stayed too stubbornly attached to its core product before it realized it needed this pivot. And either way, the turnaround will not be quick and it will not be easy. Stay away for now - Groupon hasn't gotten good enough sails to keep its ship from sinking.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was prepared for Freedonia Freelance by one of our analysts.