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Summary

  • Lowered outlook paints a clear picture of Groupon's unsustainable business model.
  • Increasing competition will hurt Groupon.
  • Even after losing almost 50% of its market cap, Groupon is still not an acquisition target.
  • Increasing short interest is another negative.
  • Groupon is a strong sell.

For Groupon (NASDAQ:GRPN), there seems to be no respite from a perpetual drop in the share price. In addition, the company's recent results were weak. Groupon, in the second quarter of 2014, reported revenue of $752 million, missing the consensus estimate of $762 million. Groupon's earnings came in at $0.01, just in line with the analysts' estimates.

Although Groupon's quarterly performance wasn't that bad, the stock fell as much as 17% after the company reported Q2 results. Groupon lowered its outlook for the third quarter, and expects revenue of $720 million-$770 million on EPS of $0.02-$0.03. The lowered outlook highlights the fact that Groupon's turnaround doesn't look likely and the company will continue to struggle. Let's take a look at the reasons why I think Groupon is a strong sell candidate.

What gives?

Although Groupon's revenue grew 26% year-on-year, but with its declining gross margins, this revenue could only convert to just 2% higher gross profits. The company is doing very well when it comes to increasing sales, revenue, and acquiring a base among customers, but is unable to keep up with the profit margins.

Groupon shares rose more than 5% after Priceline (NASDAQ:PCLN) announced that it is acquiring online reservation service provider OpenTable (NASDAQ:OPEN), due to which Groupon will have one competitor less to face. This is what excited the investors, but there is another side to the story too.

Groupon's restaurant reservation service, known as Groupon Serve, which was launched last year, helps customers to find and book tables and receive discounts on their restaurant bills, while OpenTable is a restaurant reservation player which seats over 15 million diners every month at around 31,000 restaurants across the world.

Now, as it is known that Priceline is a huge hotel and flight reservations company with a market cap of $60 billion, it will use OpenTable to serve its customers with an integrated solution which will allow the booking of flights, hotels and restaurants handily. Hence, this acquisition is straightaway a threat for Groupon.

Intense competition

Groupon will have to struggle hard to turn in profits while competing against industry giants such as Amazon.com (NASDAQ:AMZN) and eBay (NASDAQ:EBAY). Amazon is one of the biggest online players, selling products at aggressively low prices so as to gain market share, even at the cost of profit margins.

On the other hand, eBay works differently. It is an e-commerce platform and not a retailer, though it has established a solid position in its segment. Also, with a valuable strategic asset like PayPal, eBay continues to encounter success.

Groupon's turnaround is what was likely to help it in the future, but that too isn't working in favor of the company. Even if the turnaround goes on well, as expected by management, there are still possibilities of the firm's stock to be highly volatile.

Not an acquisition target

Groupon has underperformed the industry by a huge margin. The company's net income has decreased by almost 850% year-over-year, while the net operating cash flow plummeted nearly 340% in the same time period.

The fundamental weakness has resulted in an obvious drop in share price. Groupon is down over 44% this year, and this has led many investors to believe that the company is ripe for a takeover bid for companies like Google (GOOG, GOOGL). The acquisition of OpenTable by Priceline has further fueled the optimism. However, this may not happen. Google already has a big market share in the advertising market, and it will not waste money on acquiring Groupon. Thus, I think acquisition is off the table.

Short interest

Despite the "cheap valuation", the short interest in Groupon is consistently rising. As of June 30th, there was short interest totaling 80,506,749 shares, a growth of 6.0% from the June 13th total of 75,974,617 shares. This means that currently, over 17% of Groupon shares are sold short, and not everyone believes in its turnaround story. The high short interest is understandable, as Groupon has an unsustainable business structure. The company's revenue growth has not translated into a growth in profitability, and the high operating expense ensures that this trend will continue.

Conclusion

Hence, it can be said that there is no point in investing in Groupon. The company is under severe pressure from different areas, and the increasing competition will hurt its performance further. So, it will be a good idea for investors to keep a safe distance from Groupon.

Source: Why Groupon's Turnaround Looks Like A Pipe Dream