Groupon's Bears Are Getting Worried - They Should Not Be

| About: Groupon, Inc. (GRPN)

Summary

Groupon is heading toward the $1 mark, which will make it a penny stock. The decline is backed by the fundamentals.

On the options market, bulls are expecting a bounce back in the next 12 months, as data show. Writers have adjusted premiums accordingly.

On the contrary, some put options are trading at a discount. Bears may want to leverage their positions with these instruments.

As Groupon (NASDAQ:GRPN) is racing to become a penny stock, analysts from major brokerages are becoming more and more bullish on the stock:

"Recently stock market analysts have updated their consensus ratings on shares of Groupon, Inc. The latest broker reports which are currently outstanding on Tuesday 12th January state teo analysts have a rating of "strong buy," 2 analysts "buy," 15 analysts "neutral," two analysts "sell" and 0 analysts "strong sell."

(Source: Risersandfallers.com)

Most recent broker ratings:

12/11/2015 - Groupon, Inc. had its "outperform" rating reiterated by analysts at Macquarie. They now have a USD $3.50 price target on the stock.

11/04/2015 - Groupon, Inc. had its "neutral" rating reiterated by analysts at UBS. They now have a USD $3.20 price target on the stock.

11/04/2015 - Groupon, Inc. had its "neutral" rating reiterated by analysts at B. Riley. They now have a USD $2.50 price target on the stock.

11/04/2015 - Groupon, Inc. had its "hold" rating reiterated by analysts at Evercore ISI. They now have a USD $3 price target on the stock.

11/04/2015 - Groupon, Inc. was downgraded to "neutral" by analysts at Sterne Agee.

11/04/2015 - Groupon, Inc. was downgraded to "market perform" by analysts at Wells Fargo.

11/04/2015 - Groupon, Inc. was downgraded to "underperform" by analysts at Bank of America Merrill Lynch. They now have a USD $2.75 price target on the stock.

11/04/2015 - Groupon, Inc. was downgraded to "neutral" by analysts at Piper Jaffray. They now have a USD $2.5 price target on the stock.

11/04/2015 - Groupon, Inc. had its "sector perform" rating reiterated by analysts at RBC Capital. They now have a USD 4 price target on the stock.

11/04/2015 - Groupon, Inc. had its "buy" rating reiterated by analysts at Brean Capital. They now have a USD 5 price target on the stock."

(Source: ​Risersand​fallers.com)

Analysts seem to have forgotten that a bad business is bad at any price.

I have not personally used Groupon or any similar service for a year or so. Why? I have noticed that many small companies have become active in online marketing and offer deals on their own. They can do without Groupon. And I do not have to waste my time going to Groupon's website to find deals - I can simply check a company's website or page on the social network and see what discounts it currently offers. It seems to me that, as people become more and more Internet-literate, they will need services of middlemen like Groupon less and less.

In the meantime, Groupon has managed to double its sales over the last three years:

Click to enlarge

(Source: ​Google Finance)

However, this has been done at the expense of profits:

Click to enlarge

(Source: Google Finance)

Fiscal 2015 has been stagnant - the last 12-month data show that it will likely deliver revenues in the neighborhood of $3.2B - $3.3B, the same as during the year before. The company still generates positive free cash flows but the gap between operating cash flows and capex has been continually narrowing. As the share price falters, Groupon uses cash to buy back shares: the company has spent $37.5M to buy back stock in 2013, $147M in 2014, and over $320M in the first nine months of 2015. Unfortunately, this did not help the stock much:

Click to enlarge

(Source: Bloomberg)

​I have noticed something interesting in the options market for this stock. In particular, I have looked into the options expiring a year from now, in January 2017. Apparently, options investors discount the probability of the stock going below $1 per share, while selling call options at a premium at the same time, fearing that the stock may bounce back a lot higher in the next 12 months:

(Source: Google Finance. ​Calculations by author)

Note: I used the Black-Scholes model to do the calculations.

As you can see, every single call option on the list is overvalued as the writers have factored in unrealistic expectations about the stock's volatility in the future. My historical price analysis has showed that the annual volatility of roughly 57% is the highest figure achieved in the last three years. On contrary, bearish investors are not confident that the stock may go down even lower. As a result, readers can see that there are opportunities among the puts: both in the in-the-money and out-of-money securities.

Which option strategy would you choose? Keep in mind that mathematical assumptions are only one side of the coin. If there are positive factors you can identify with the company during this year, paying a premium to the fair value may still be a good strategy. On the other hand, if you are bearish like me, put options is your best choice: not as risky as going short with the shares and, apparently, more profitable given the discounts to the fair values.

Read the full analysis here.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I may buy put options in the next 72 hours.