Can Mason's Exit Trigger Groupon's Renaissance?

Mar.21.13 | About: Groupon, Inc. (GRPN)

Groupon (NASDAQ:GRPN) reported Q4 and FY 2012 results on Wednesday, Feb. 27. This news did not delight investors, as the company's stock plunged about 28% following the announcement. Groupon's daily deals business posted improved results, but this still wasn't enough to trigger an upswing in the company's profits. A few weeks later, the departure of the company's CEO was announced thrusting the company into a state of dilemma. Questions are being asked whether the company could do better without Andrew Mason as CEO.

Groupon's Q4 and FY12 results came short of expectations and consequently meant the end of an era for Mason

Groupon operates as a local commerce marketplace that connects merchants to consumers, offering goods and services at a discount in North America and internationally.

According to its earnings statement, Groupon reported billings of $1.52 billion, significantly above the Street estimate of $1.33 billion. But revenue of $638 million merely matched consensus estimates. This was attributed to the company's strategy to accept lower take rates in order to attract higher-quality merchants. Take rate was down 469 basis points from the previous quarter. However, according to a note to investors from Arvind Bhatia of Sterne Agee, the company's take rates are expected to stabilize and improve in the coming quarters.

Mobile accounted for 40% of the company's overall revenue, up from 33% in the previous quarter. Groupon's "search" marketplace has taken off with giant strides, with 50% of local transaction volume already attributable to it; this marketplace now boasts 37,000 active deals, up 300% year over year. Could this be the daily deals company's last throw of the dice? If so, then things look promising, ceteris paribus.

However, one of the major reasons why despite the increase in revenues the company's profits performed dismally is the Operating expense, which grew as the company invested in merchant quality and new initiatives. However, marketing costs were well-managed, declining by 15% from the September quarter, and 61% year over year. Overall operating profits (non-GAAP) came in at $14 million, far from the Street estimate of $40 million.

The thin line between life and death

Groupon sends daily emails to its subscribers regarding discounted offers for goods and services that are targeted by location and personal preferences. Consumers also access its deals directly through the company's Website and mobile applications. This line of business puts Groupon in direct competition with industry giants like Google (NASDAQ:GOOG) and Facebook (NASDAQ:FB). Sadly for Groupon, those two hold a huge advantage against it.

Groupon offers links to discounted products and services, which is perceived to be one of its strengths. But Google has already come up with new methods to drive users to various products according to their search terms. It is no longer about Google AdWords, but Product Listing Ads (PLAs). Whenever a user enters a search query relevant to an item in a Google merchant center account, Google will automatically show the most relevant products along with the associated image, price and product name. This would without a doubt tramp Groupon's advances to a turnaround if its alternatives continue to diminish.

Merchants are also expressing high level of adoption of PLAs. According to Google's Q4 earnings results, during the fourth quarter of 2012, PLA budget investments increased by a whopping 600 percent to 2.5 percent from 0.36 percent in October. Over the 12-month period, they increased by 210 percent, from a paltry 2.1 percent in January to 6.6 percent in December.

Facebook will be challenging Groupon with its Ad exchange dubbed FBX. It will also provide another headwind for Groupon with its Sponsored stories, an investment that is beginning to pay-off generously. Facebook also boasts a massive user base, which means that Merchants have a larger pool to fish.

The social networking giant's sponsored stories unit was already generating an estimated $1 million per day, by July 2012. The company also introduced promoted posts and a gift service to boost its ecommerce business. However, it is FBX, which stands to down Groupon to the floor if all goes well.

Facebook is using its users' data to great advantage. The company has access to a lot of information related to its more than one billion monthly users. It is using this to target Ads to its members whenever they browse the internet, whether via mobile application, or web, and regardless of their login status.

The Bottom Line

Sterne Agee analyst Arvind Bhatia is of the opinion that Groupon could be troughing in the next three to four quarters, signifying a successful turnaround. The analyst expects the company to improve on its take-rates, and operating expenses. That said, Groupon is showing no signs of sustainable growth in revenues. The analyst just cut his estimates for the next two years, which indicates that Groupon could actually see a decline in revenues going forward.

The analyst now expects the company to report $2.9 billion in FY13 down from $3.3 billion, while the expectation for 2014 is $2.5 billion from the initial $2.9 billion. He noted that the company's stock would be a good buy for investors willing to play around with its turnaround, but on a long-term perspective.

For me, this sounds more like "buy it at your own risk", as taking risks is what surmounts to returns. However, now that Mason is out, there is likely to be some good rapport between the management and the board. This would also be a good thing for the company's ordinary shareholders, as an end to boardroom wars could set a new beginning.

There is a lot of opportunity in the company's business, the downside being high competition. Nonetheless, it's the competition that brings the best out of a company, and of course the worst, and Groupon would be categorized in one of the two in the next few years. If you must own this stock, then you also need to think long-term, as the road to recovery is long and rough.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.