Seeking Alpha
Research analyst, long/short equity, tech
Profile| Send Message|
( followers)  

Facebook’s announcement of closing its local deals business merely 4 months after it started has sent mixed signals for the future of the daily discount business. [1] While deal giant Groupon (NASDAQ:GRPN) should naturally be happy that it has one less competitor to fight against (a big one too, with over 750 million users!), the decision also raises questions on whether capital-intensive daily deals are a viable option in the long term. Facebook Deals was competing with other large companies in the daily deal segment such as Google (NASDAQ:GOOG), Groupon and LivingSocial, along with hundreds of other daily deal clones worldwide.

We currently value Facebook at around $45 billion.

Groupon Has One Less Reason to Stay Up at Night

Facebook’s closure of its local deals business is good news for Groupon, which has seen numerous competitors enter into the local deals sector due to extremely low barriers for entry. With over 750 million users, Facebook has a tremendous network and scale effect which it could take advantage of to bring in more subscribers compared to Groupon’s existing subscriber base of over 115 million.

With its core business centered around bringing people together, Facebook clearly overshadowed Groupon in terms of its social media reach, which could have translated into group buying initiatives. Facebook’s exit is also a loss for smaller deal sites such as ReachLocal and Gilt City, which were promoting their deals through Facebook.

But It Also Reflects the Enormous Challenge of Reaching Profitability

The Facebook Deals closure also indicates how even big tech companies with multiple (stable) sources of income are finding local deals to be exceedingly challenging to execute. Promoting and selling discount deals is a highly capital-intensive business, requiring a strong sales force and high marketing costs to acquire and retain both merchants and subscribers.

Given that Facebook is almost a pure technology background, it seems that Facebook is deciding to commit less to running a business model that heavily depends on employing sales reps and handling complaints. Facebook is notoriously hard to get a hold of on the phone for instance if you want to shut your account.

The decision also raises some serious questions over the long-term profitability of deal providers like Groupon whose financials clearly show a trend of rising expenses. [2] Groupon has spent over $800 million in marketing and administrative expenses in the first half of 2011, which is roughly 55% of its revenues, and the ultimate operating leverage associated with this business model remains unclear.

Notes:

  1. Reuters: Facebook Ending Deals Product After Four-Month Test
  2. Groupon’s S-1/A Filing

Disclosure: No positions

Source: Facebook Deals Closes: An Alarm Bell Groupon?