The (Continuing) Bear Case On Groupon Inc.

Jul.11.14 | About: Groupon, Inc. (GRPN)

By Michael Ide

Sentiment may be turning for Groupon, but some analysts are still unconvinced it will ever be profitable

When Groupon Inc. (NASDAQ:GRPN) first went public at $20 per share, it was the latest example of an overhyped tech stock for prudent investors to avoid, and sure enough, it fell by 90% in its first year. But since then its revenues have continued to grow and sentiment has pushed its stock price from sub-$3 lows to more than $12 at the beginning of the year, and pulled it back down to $6.60. While some analysts see this as an attractive entry point, others doubt that its revenue growth will ever show up as an actual profit.

Groupon Inc GRPN

"In the three years since Groupon Inc first became publicly traded, the business fundamentals have deteriorated and the stock price has subsequently fallen to the mid $6 level today," writes former hedge fund analyst Jeffrey Himelson. "The most prudent action taken by GRPN's management was timing an IPO well and cashing out while they could."

Revenue hasn't yet translated into profitability

Groupon Inc.'s revenue has grown 26% year-on-year, but because its gross margins continue to fall (84% at the IPO to 51% now), that revenue translates to just 2% higher gross profits. The problem is that Groupon's business model just isn't that hard to duplicate, and even though it's still at the top of its niche, its daily deal sites continue to proliferate, putting even more pressure on margins.

Groupon Inc

Himelson acknowledges that there are some possible catalysts to boost profits, but he doesn't find any of them particularly convincing. The growth of mobile computing has improved the size of the daily deal market in general, and Groupon Inc. has been aggressively expanding internationally, but neither of these positive developments matter unless Groupon can stabilize its margins. Groupon has also launched a point-of-sale system called Gnome, but it will have to prove that it can steal market share from established POS brands like Square before investors make Gnome a significant part of their long thesis.

Groupon could be an acquisition target

With such a negative view of the company, you might expect Himelson to recommend shorting Groupon Inc., but the possibility that another company will acquire Groupon holds him back. While he has no faith in Groupon as a standalone company, someone else might be able to capitalize on its strong brand name and platform to drive customers toward more profitable offerings. And if Groupon's stock price gets low enough, the possibility of someone else acquiring it could become a long thesis of its own.

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