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If you go by recent articles by Seeking Alpha contributors, the prognosis on Groupon (GRPN) is overwhelmingly negative. Groupon is "On the Road to Bankruptcy", "Poised for Collapse" and at "The Beginning of the End". The stock has gone from an intraday high of 18.98 on March 30, 2012, when the revised 10-K was filed, to a low of $12.95 on April 11, 2012, a drop of over 30% in less than two weeks. The share price has since then recovered slightly to close at $13.12 on April 13, 2012, sporting a market cap of $8.5 billion. With so much contrary sentiment, a positive earnings report (due May 14, 2012) could spike up the stock. We believe this provides an excellent play based on both fundamentals and the near-term psychology of the market.

Groupon's Amazing Cash Conversion Cycle [CCC]

The Cash Conversion Cycle is the length of time it takes, in days, to convert a company's resource inputs into cash flows. It is calculated by adding

Cash Conversion Cycle = Days Inventory Outstanding [DIO]

+ Days Sales Outstanding [DSO]

- Days Payables Outstanding [DPO]

Groupon carries no inventory so its DIO is zero. We calculate its Days Sales Outstanding for 2011 by dividing the average of its beginning and ending Accounts Receivables over the period by its Average Revenue per day. We calculate its Days Payables Outstanding for 2011 by dividing the average of its beginning and ending Accounts Payables over the period by its Average Cost of Sales per day.

Here are the figures for Groupon for 2011:

Days Sales Outstanding

Notes

Accounts Receivable [AR]

$75,577

Average of end 2010 and 2011 from balance sheet

Total Sales [S]

$1,610,430

FY 2011

Days [D]

365

Days in 2011

Days Sales Outstanding [DSO]

17

=AR/(S/D)

Days Payables Outstanding

Accounts Payable [AP]

$49,231

Average of end 2010 and 2011 from balance sheet

Cost of Sales [COGS]

$258,879

FY 2011

Days

365

Days in 2011

Days Payables Outstanding [DPO1]

69

=AP/(COGS/D)

Cash Conversion Cycle

-52

=DSO-DPO1

Source: Groupon 10-K, 2011, $ in thousands

So Groupon has a negative cash conversion of -52 days. In essence, it is a business that gets paid to make money. It is funded by its suppliers. Other notable businesses that have a negative cash conversion cycle are Amazon (AMZN) and Dell (DELL), both incredibly efficient in their generation of cash. Moreover, Groupon also has accounts payables for its merchant partners. It pays its merchants much later than it receives money from its customers. Here are the total payable numbers after including the Merchant Payables [MP].

Days Payables Outstanding including Merchant Outstanding

Accounts Payable +Merchant Payable (AP+MP)

$390,797

Averages of end 2010 and 2011 from balance sheet

Cost of Sales [COGS]

$258,879

FY 2011

Days

365

Days in 2011

Days Payables Outstanding [DPO2]

551

=(AP+MP)/(COGS/D)

Cash Conversion Cycle

-534

=DSO-DPO2

Source: Groupon 10-K, 2011, $ in thousands

Here the CCC is -534 days, a mind-boggling negative year and a half of "free loan" of cash for its payables. Note that these payable do not include "Accrued Expenses" with the much discussed return reserves, set at $67,452 in the 2011 balance sheet. Including this would further lengthen the negative CCC.

What about the reserves?

One issue that has been highlighted by the issue of material deficiency in Groupon's 10-K is its reserves for returns. As Felix Salmon points out, Groupon has booked only 1.69% of its total revenue (Groupon calls this "gross billings") for its return reserves and may incur more liability if its return rate is higher, since the merchant may already have been paid beforehand. There are two factors to note about this. Firstly, this situation only applies to Groupon's North American business since, according to the 10-K "In our International segment, merchant partners are not paid until the customer redeems the Groupon."

What percent of revenues is Groupon booking from international sales? From its 10-K:

Year Ended December 31, ($ in thousands)

2009

% of total

2010

% of total

2011

% of total

North America

$ 14,540

100.00%

$ 200,412

64.00%

$ 634,980

39.40%

International

-

-

$ 112,529

36.00%

$ 975,450

60.60%

Total Revenue

$ 14,540

100.00%

$ 312,941

100.00%

$1,610,430

100.00%

So based on these figures, international revenues have increased from 0% in 2009 to over 60% in 2011. This 60% of the business does not have the issue of the liability overhang from the merchant being paid in advance of the Groupon being used, which has been the major ding against the company. Furthermore international revenues are expected to go up as a percentage of overall revenues. Note that total return reserves as a percent of 2011 North American revenues (not "gross billings") are more than 10%. Anecdotally, I have personally bought many Groupon deals, far above their average sales per customer, and have immensely enjoyed each one of them and have yet to experience buyer's remorse on even a single transaction. To me, the Groupon Promise is a net positive. As long as Groupon continues to delight its users, the merchants are sure to follow.

Overall, Groupon is a rapidly growing business that has the capacity to throws out an amazing amount of cash. For a business growing at a nearly 100% run rate it is trading at nearly 4x forward revenues. Note that these revenues have a gross margin of over 80%. For 2011, it generated $290+ million of cash from operations and is trading at 30x trailing cash flow. It would not be surprising to see its double its cash from operations in 2012 over 2011 and generate over 600 million of operating cash flow. There are legitimate questions of how long this torrid growth can continue, but at these numbers, Groupon is a strong buy. Conservative investors may want to buy call options or use bull call spreads to benefits from Groupon's growth while limiting downside.

Groupon has gone down far too quickly, based mainly on fear. A positive surprise in the next earnings report on May 15, 2012 could easily return it back to where it was trading just two weeks ago at $18+. One trade we like is buying calls expiring on May 19, 2012 or setting up May call spreads. Buying May calls with a strike price of 15 and selling calls with a strike price of 18 currently cost around 50c per call spread position and can yield $2.50 (500%) in profit if the stock closes at or above $18 at expiry. Note that if the stock closes below 15 at expiry you will lose your entire investment if you hold till then. You may be able to profit without holding to expiration if the stock rises between then and now. Longer term investors may buy long-term calls or set up bull-call diagonal spreads or purchase the shares outright at these prices.

Disclosure: I have bull call spreads on GRPN.

Source: Profit From Groupon While Investors Are Negative