Groupon: A Business That Does Not Easily Scale

| About: Groupon, Inc. (GRPN)

As Groupon (NASDAQ:GRPN) reports yet another loss, several things become evident.

One of them is that the business Groupon is developing, in the local deals space, does not scale easily. For increased activity, the sector requires increased resources, in the form of an army of salesmen that need to contact and get the local deals with local merchants. With more than 10,000 employees already for yearly revenue of $1.6 billion, it shows how distant the model is from Facebook (2011 revenue $3.7 billion with 3,200 employees) or Google (NASDAQ:GOOG) (2011 revenue $37.9 billion with 32,400 employees).

Still, also evident is that Groupon will turn profitable. It's already showing free cash flow, and within one or two quarters it should start showing profits, which is not the same as saying that it will be worth the market capitalization it trades at (around $14.9 billion).

The Main Problem

The main problem remains what we observed: The business is not lending itself to be levered - it's requiring too much manpower. For the business to be truly stellar, it would have to evolve into the kind of business Google's AdSense is, where the local businesses themselves would set up the campaigns with little human intervention from Groupon's salesmen.

It's no wonder why the daily deals sector has already been abandoned by some large competitors, such as Facebook and Yelp. We also got to know, through (NASDAQ:AMZN)'s 10-K, that LivingSocial produced a $0.5 billion loss in 2011. still carries a 31% interest on LivingSocial, so almost a third of that loss really is Amazon's to bear. One wonders for how much longer such losses can be allowed.

Another large competitor dipping its toe into the industry is Google with Google Offers. However, recently Google seems to also have changed the focus from trying to build out the segment all by itself, to also carrying other competitor's deals.


Groupon will soon turn profitable, but its earnings release shows the daily deals sector does not scale well, and even when profitable it will never be the kind of pure high-margin Internet business that other companies, such as Facebook and Google, epitomize. Thus, it's hard to see how Groupon can warrant the huge valuation put on it by the market, especially taking into account that revenue growth is now expected to slow dramatically while profitability, though it will make an appearance, won't be extraordinary.

Disclosure: I am short AMZN.