In November last year, the company offering discounts to buyers had a remarkable IPO at the Nasdaq stock exchange, which was the largest among Internet companies since Google's (GOOG) IPO in 2004. Underwriters have sold about 35 million shares at $20 per share through increasing the share offering price and its number. This signified that the company's capitalization was about $13 billion as well as that the company attracted about $700 million of capital it desperately required for development. More insightful speculators managed to sell their shares with a profit, while the less risky ones remained with either paper or fixed loss. It hurts to watch and to bear an investment that has dropped from $20 to $5 in less than a year. Groupon (GRPN) shares were that kind of an investment instrument.
I have always been cautious in regard to the so-called hot IPO of non-profit technological companies and have not taken part in such offerings. Practice shows that it is less risky for an investor (not a speculator!) to wait for the beginning of trades (for the appearance of earnings is even better) and buy liquid shares on the open market. Groupon stands as another proof for that truth (see the company's shares graph below).
We should also mention that the investment bankers have brilliantly chosen the time for Groupon IPO, just as they did with that of Facebook (FB) (they know what they are doing!). The quarterly report following the offering was able to support Groupon shares at the price of IPO, while the 2011 annual report marketed the beginning of the stock prices free fall. Groupon offered class A shares, with the voting right of 1 vote per share. At the same time, the founders own all class B shares with the voting right of 150 votes per share as well as a part of class A shares. As a result, the majority stake at the shareholders' meeting belongs to the business founders. This is especially significant when voting for a purchase or merging of companies, which I will mention later. By the end of March 2012, there were 343 registered shareholders which is not a large number for a company with a 10M shares daily turnover. Groupon capitalization is $3.3B as of September 20, 2012 (over 70% less than the capitalization at IPO).
Let's analyze Groupon business-model, the reasons for the current situation, the company's advantages and disadvantages and drawing conclusions for the future. The service of Groupon, Inc., a company founded in October 2008, consists in creating a new way to attract clients for business via internet. Traditionally, local sellers attract customers through papers, Yellow Pages, street advertisers, etc. Groupon offers benefits both for the sellers offering commodities to the target audience on a certain territory and to the buyers who wish to get discounts for the goods and services they are interested in. Judging by its market share, Groupon does what it does quite successfully, being the market share leader in 37 out of 48 countries where it has presence.
Groupon services include the following: Featured Daily Deals, when the company sends the best offers from local sellers of goods and services providers to the target audience daily; Groupon Now! is a service launched in order to control the customer flow at a certain time, for example, during the period of day or month when the demand is traditionally low while the potential customers are hungry or bored; Groupon Goods consists in selling discount vouchers for commodities through the web-site; Groupon Getaways offers tourist industry promotions; Groupon Live offers concert tickets and tickets for events interesting for clients; Groupon Rewards is a marketing decision launched to gain clients' loyalty.
Groupon makes money through collecting payment from clients and gaining the so-called gross billing, which does not equal to the company's revenue. Then Groupon pays the negotiated price to the commodity or service provider, following an exclusive sale agreement signed for a certain term. Groupon pays the North American companies within 60 days from the sale of a product or service to the end consumer. Per the rest of international companies, the payment is realized after the client has paid and used the service or has purchased the product. Therefore, Groupon has an opportunity to use the clients' money to finance its working capital.
The difference between what Groupon receives from the customer and what it pays to its client represents the sales level. For example, in the 4th quarter of 2010, Groupon earned 41.5% of the Gross Billing amount and 40% of Gross Billing amount in the 4th quarter of 2011, i.e. the company's "commission" is fairly high. It is an unusual situation considering low industry penetration borders and high competition.
The company actively invests into acquiring the potential clients' databases, namely businesses possessing technologies which would enable Groupon to benefit in the future. In Europe, the company has partnered with Deutsche Telekom (DTEGF.PK) which enables Groupon to distribute its mobile app to clients through smartphones provided by the European giant. In the USA, the company has partner programs with eBay (EBAY), Microsoft (MSFT), Yahoo! (YHOO), Zynga (ZNGA), thanks to which Groupon Daily Deals appear and are promoted on the mentioned companies' web-sites through their client database in exchange for a part of sale revenues. Above that, the company acquires subscribers via word-of-mouth advertising, search engines marketing, banner advertising, TV, radio, sponsor programs, social networks, its web-site and mobile applications. With the growth of business, Groupon forecasts that marketing expenses as a % from sales for attracting subscribers will decrease. This index has a clear downgrading tendency having dropped from 78% in the 1st quarter of 2011 to 21% in the 1st quarter of 2012, while marketing expenses within the international sector of the business are higher than those within the North American.
A short company history is presented in the table below (extract from 10-K):
The table below shows the actual and forecast quarterly revenue dynamics proving the company's growth slowing tendency. In 2008, Groupon sales were $5 and impressive $1.6B in 2011. The company receives about 55% of sales from its international activity and 45% from the North American, meaning the company is global.
The main expenses are not Costs of Goods, but Marketing Costs which are the expenses for attracting new subscribers and expenses for attracting new business clients reflected in Selling, General, and Administrative Costs.
However, despite multiple growths of sales, the number of subscribers, planned income in 2012, strong balance two thirds of which is represented by cash and its equivalents, the investors are still skeptical in regards to Groupon. Why?
First of all, Groupon announcement regarding its significantly loose internal financial statements control procedures on the background of the Chinese companies reporting scandals disappointed the investors: the 2011 numbers seemed doubtful in such case. Despite the right decision to hire a professional with many years of work experience with KPMG, the spot in the company's history and investors' memory remained.
Secondly, the company is slowing down. We will hardly witness the multiple growth rates of the last three years in the future. For example, in 2011 the company's revenue was $1.6B (433% growth compared to 2010). By the results of 2012 the revenue is expected at $2.4 B, meaning the growth is 50%. The expected revenue in 2013 is $2.8B, i.e. only 17% growth compared to the previous year.
Growth (y/y), %
The barrier to enter the industry is low, and competition will increase which means that it would become more difficult to support the "commission" level of a deal at 40% every year. Moreover, the mere notion of "a discount" is vague in regards to the sale of products and services. For instance, in public catering industry where the margin is high, it is realistic to offer a 30% discount. However, such discounts are hardly applicable to most commodities producers. Per long-term perspective, it seems that the company's clients will mostly be new businesses willing to inform customers about its product. While the question whether the customer will return for another purchase depends on his/her satisfaction rather than on Groupon efforts. Mature businesses may also use Groupon services from time to time, but they cannot keep selling their product or service at half price for endlessly long period at the expense of profitability.
In order to increase its sales and market share, the company actively invested into sales force. By the end of 2011, over 5000 sales representatives around the world worked for Groupon. The table below shows their growth and regional distribution.
Groupon was founded in 2008, the year of "the Great Recession." Such services are popular during crisis when people tend to save. I do not think that the global issue will be resolved in the nearest years to come, however, with greater stability, the businesses will be providing less discounts seeing the possibility to sell for more, and the end consumers will more incline to consume products and services even though discounts would not be provided. Professional sales representatives are a significant asset for the company. It is strategically more important for Groupon to attract businesses which would sell their services with discounts. Attracting an end consumer, for instance, to a restaurant having discounts appears to be an easier task. At the same time, competitors act similarly, hiring sales representative around the globe. With tightening competition and decreasing level of "commission," keeping sales representatives working off commission is possible only at the expense of business profitability for companies like Groupon.
Despite the launch of Groupon Rewards program, end consumers tend to choose a product based on the price rather than the brand. From my point of view, such business loyalty to a company like Groupon is doubtful. If an average consumer finds the same product offered by another "discounter," he/she would rather go there, it is the discount-hunter psychology.
So, the Groupon IPO share price of $20 was indeed overstated, but what can be said now, when the price is about $5 per share or even less? The $5 rate is a psychological benchmark, and if the management believes in the future of the company, it can regard the possibility to repurchase shares from the market if there is over $1B of cash available on the company's balance sheet (a third of the business capitalization!) and almost no debts. This will cause short-sellers to panic, considering that 20% of all the shares traded were shorted by the end of August. On the other hand, if the management does not believe in the company's future, Groupon can be a target to be purchased by the giants like Amazon (AMZN) or Google. It would be especially beneficial for Amazon to exchange shares with Groupon now, taking into account Amazon's overestimated shares.
In September 2012, the company launched Groupon Payments to promote the business synergy and margin growth, which is a strategically correct decision. From now on, businesses that use Groupon services have an opportunity to pay less for processing their transaction thus increasing profitability. The new service caused a positive reaction of the market: GRPN shares increased by 13% on the announcement day with the volumes increasing by 3.2 times the average.
Based on current rates, the ratio of Groupon capitalization to the sales is lower than the industry average (1.7 and 2 accordingly). The company is expected to gain its first earnings of $0.18 per share in 2012. The earnings expected in 2013 are $0.37 per share. This stands for P/E in 2012 is 29, while the expected P/E in 2013 is 14.4. Taking into account the expected earnings per share growth at 30% rate in the coming 5 years, considering relative indexes, Groupon does not appear to be very expensive even for value investors at the moment. What remains is to fulfill the expectations of earnings.
So, Groupon is a global company, but at the same time, its shares are speculative today. I would hardly include its shares into a portfolio of a long-term investor, whose objective is to accumulate pension savings or funds for education due to the existence of better alternatives. At the same time, Groupon's price level may be attractive for speculators.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: This article contains the opinions of the author. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service. Performance data shown represents past performance. Past performance is no guarantee of future results. No part of this article may be copied, distributed, transmitted or published without the prior written consent of the author.