Groupon (GRPN) is one of the most hyped Internet stocks to IPO in the last couple of years. The company raised over $800 million from investors caught in the Internet 2.0 mania. The company, whose business model consists of selling discount deals, has dealt massive losses to its investors. Groupon's stock has declined by over 70% in the last year due to a number of management blunders and a weak business model. After hitting a low of $2.6, the stock has more than doubled to $5.35 in the last couple of months. We think that investors should sell into the rally as the company does not have a coherent business strategy and suffers low competitive barriers with slowing growth prospects.
Why we would sell Groupon
Weak Business Model - Good technology companies are characterized by high margins, scalability and a wide moat around their business model. However we find none of these features in Groupon. The company spends almost nothing on R&D, has few patents to its name and scalability is almost non-existent. The company has managed to grow revenues at a fast clip, by growing expenses at an equally fast rate. GRPN has to employ a large sales force to engage with numerous small merchants. This means that scaling up profitably in its core business area is almost impossible.
Very low competitive barriers - The company's business of selling discount deals has almost no competitive barriers. It requires almost no technology and very little expenditure to start a daily deals website. The company faces competition in the U.S., from strong competitors like Living Social and Google (GOOG). The company faces numerous competitors in international markets as well. In India, we could count almost 20 daily deal websites with some of them owned by the biggest Indian Internet companies like Rediff (REDF) and Indiatimes. Due to rising competition and low profitability, Snapdeal (India's biggest discount deal website) has changed its business model to an online retailer.
Unstable Management - the company's management has been repeatedly rocked by rumors that its CEO will be replaced. The ownership structure is highly skewed, with the promoters holding the majority voting stock. This means that it is almost impossible to change the entrenched interests, even if they run the company into the ground.
Lack of a coherent business strategy - It is quite difficult to understand what the company is trying to do. The company is trying to diversify away from its core discount deals business model, into both payment processing and online retail. The company is trying to compete with global giants like PayPal in payments processing; and Amazon (AMZN) and eBay (EBAY) with Groupon Goods. We wonder whether the company has done its due diligence before venturing into these new areas. The company has been buying technology startups in these areas. However, integrating and consolidating acquisitions is a tough task even in normal times.
Lack of margins in fastest growing segment - Groupon has a gross margin of just 12% in its fastest growing segment - Groupon Goods. We don't understand why the company is trying to compete in the hyper-competitive Internet retail space.
Valuation is not cheap - Groupon stock is not cheap, despite falling by almost 80% from its peak of ~$26. The company trades at a P/B of 4.4x, which is almost 20% higher than the industry average at 3.6x.The company trades at a relatively expensive forward P/E of 31x and a P/CF of 9x. It is not a value stock by any means and is not showing any growth characteristics as well.
Growth has flattened out - GRPN grew quite spectacularly in the last couple of years, but growth has flattened in the last few quarters. The daily deals revenue has decreased in the last few quarters, which have been made up by the low margin online retail business.
No traction in international markets - We think that GRPN's international business is a total disaster, based on the mistakes made in Europe and India. The company bought a small fledgling daily deals site Sosasta.com in India, (don't know why) and even bungled that up.
Accounting and Legal Problems - Groupon has been found wanting in the accounting and public disclosure areas twice in the last year. The company had to restate its 4Q11 results, after the auditor found a problem with internal controls. The company has become the target of class action lawsuits again, after there were issues regarding its revenue guidance. I would not want to invest in a company which frequently finds itself in accounting and legal trouble. It takes a long time to recover the trust of shareholders and two incidents in one year are too many for comfort.
Acquisition by bigger technology company - Google had tried to buy Groupon for $6 billion, but the GRPN management rejected the offer. GRPN now trades at a 30% discount to the original offer made by Google. There have been many expensive acquisitions made in the technology industry and it is not unlikely that Groupon could be bought by one of the technology giants like Amazon.
Stock Price Performance
The company's stock price performance has been quite abysmal, showing continuous losses since its inception as a publicly-traded stock. The stock has given a 100% bounce, after declining 90% from its peak value of ~$26. Despite the massive fall, the company still does not look attractive enough to buy and we would sell the rally to look for better options.
We don't think that Groupon offers a decent risk reward profile at the current stock price and valuation. The company is trying to enter highly competitive internet businesses, such as online retail and payments, at the same time. The company has realized its core discount deal business model is at a dead end and it is desperately trying to enter new ones. The company's CEO is not sure how long he will retain his position and the company's acquisitions don't make a whole lot of sense. We don't think management knows what it wants to do and where it wants to go. The only upside risk is if Groupon gets bought by a bigger technology company.