Another Over-Reaction-Was That 15% Or 1.5%?

Aug.14.14 | About: Groupon, Inc. (GRPN)


Groupon stock fell 15% last week when revenue missed by 1.5%.

Improvements across most operating sectors bode well.

Could there be a renewed "romance" between Groupon and Google?

Recently Groupon (NASDAQ:GRPN) released its latest earning results and missed expected revenues by 1.5%. However, "Mr. Market" reacted strongly and the run-up of the past few days quickly reversed and GRPN fell 15%. The stock fell below $6 a share and has since settled into a new range just under that mark. This is not new-almost every quarter Groupon's estimated revenue and return to profitability are forecast, the stock heads up and often even bounces just before the earnings release. This quarter was no exception-Groupon ran up from $6.40 to just over $7 in the last two trading days before the results were released.

I will honestly admit I have been negative about Groupon in the past but that was when the stock was trading as much as twice as high as it is now. When some of this froth was removed (sometimes after previous quarterly earning "misses") I have established a modest position. My rationale for this was the large cash stockpile the company maintains and improving results across business sectors that should lead to modest earnings for 2014 and continued profitability into 2015. I personal used both dollar-cost averaging and a covered call strategy to reduce my cost per share over time. While on paper I am down on about 1/3 of my shares over-all my strategy has me breaking even after the recent drop.

Other than price, why have I now become a cautious bull on Groupon? I'll point out a few reasons and link to a fellow analysts who have shaped my views instead of simply paraphrasing their arguments.

First: Overblown responses to inflated estimates

This quarter's stock action shouldn't have come as a surprise to those who have either held Groupon or watched it long-term. Most quarters estimates and predictions are rosy and target prices for the stock rise, and quite often the stock follows suit. I have already discussed what happened in early August. Looking back in May and February we see a similar pattern. Early May trading saw the stock fall even further than recently and set a new 52 week low after earnings were released May 6th. In February, the drop was 20%: from over $10 to just over $8. While price movement alone shouldn't drive an investor's decision, wise purchases when predictable disruptions occur can enable positions to be initiated or increased more favorably. If other factors remain the same, Groupon just went "on sale" as it seems to do every quarter. The stock spiked up for a few days and then dropped back down-well timed purchases or sells of the stock or covered calls on a fairly predictable pattern can't be counted on as a fool-proof strategy forever but seem to be the trend in Groupon.

Second: International strategies starting to pay off

One of my issues with Groupon has been how quickly the stock went up when it was simply a daily deal site in the U.S. Those days are over as Groupon has diversified, but the stock remained highly inflated with little earnings as leadership changed, the business was expanded and diversified both domestically and with international purchases and expansion. Additionally, the company strategically deployed the cash war chest from the IPO and bought leading international brands that made sense from a similar market perspective. While still highly valued for current earnings per share, what I considered "irrational exuberance" of the early days has blown off. Previous purchases are being integrated into the company, and consistent stock buybacks are also being used to limit shares outstanding. Last quarter overall revenue rose 23%, with Europe, Middle East and Africa (EMEA in results) -were up 42% and Rest of the World up 40%. These are good signs, and point out to the overblown nature of a 15% sell-off.

Third: Could there be a re-kindled "romance" between Google and Groupon?

SA contributor Bob Ciura does a great job stating the case for a renewed discussion between Google (NASDAQ:GOOG) and Groupon in his recent article. I would recommend anyone long either stock read his article. To personalize two corporations, Google should act like a mature lover and make another attempt to woo Groupon, and Groupon should consider the strengths of their suitor. One factor to consider is while Groupon has purchased both other companies (Ideelli, travel app Blink, SideTour, and Korean ecommerce leader Ticket Monster are some recent examples) and bought back 17.2m shares of stock with a remaining $118m on the current authorization, the company still maintains $1.30 in cash per share. This would immediately offset any acquiring company's cost. Even more importantly, a costly price war wouldn't benefit either company and likely open the door for other competitors-which Bob highlights in his article. I could expect a merger or at a minimum a partnership being considered over the next few quarters. Is a merger or partnership required for Groupon's survival? No, but there would be benefits to both companies. This would likely raise Groupon's value 25-33% quickly and still leave the stock at a discount to Google's previous offer.

So where do we go from here?

With management's efforts of the past two years starting to pay off and small profitable earnings being shown, Groupon could be on the verge of breaking into sustained profitability. A quarterly pattern of rising trading prices and volumes then a sudden drop when positive but realistic revenues are reported has happened yet again. While I am still cautious and do not have a substantial percentage of my funds invested in Groupon, I have changed from an incredulous spectator to a "long". Groupon occupies one of the "high risk" positions in my portfolio. I leave long-term estimates to other analysts but think a sustained increase in the stock price should occur once consistent profits are reported and the conditions seem to be in place. The kicker as Bob Ciura points out could be an offer by Google at a modest premium but still at a discount to the $6B purchase offer previously made. In either case Groupon could be a positive, successful trade after the recent over-reaction to a minor revenue miss.

Note: Nothing in this article should be construed to be an offer to buy or sell securities. It is meant for educational purposes and not a solicitation of any form. Individuals are recommended to conduct their own research and decision-making before making investment decisions including stock purchases or sales.

Disclosure: The author is long GRPN. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.