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Groupon (NASDAQ:GRPN) has faced investors' wrath over the last year. After the magical IPO, GRPN plunged to $5-$6, shedding 80% of its IPO value. The company reported an increase in revenues from $312 million to $1.6 billion between 2010 and 2011. Investors are not complaining about revenue growth, but rather about continued losses due to minuscule margins. We believe the company is finally turning a corner, and current valuations (14x P/E) are on the lower side. Therefore, we believe the stock is underpriced and are giving a buy rating for GRPN.

 

GRPN

(NASDAQ:AMZN)

(NASDAQ:FB)

(NASDAQ:GOOG)

Forward P/E

14x

103x

32x

15x

Earning History:

GRPN is a very good example of investors overreacting due to missed expectations. We believe Wall Street was not justified in valuing GRPN at $25 apiece; however, a P/E of 14x for a business with immense growth potential is also not justified. The table below reveals that the company exceeded analyst expectations in the last quarter.

Earnings History

 

11-Dec

12-Mar

12-Jun

EPS Est

N/A

0.03

0.01

0.03

EPS Actual

N/A

-0.02

0.02

0.08

Difference

N/A

-0.05

0.01

0.05

Surprise %

N/A

-166.70%

100.00%

166.70%

Source: Yahoo Finance

Fundamental:

The table below shows that the company has shown a consistent revenue growth over the last three years. Revenues have grown by approximately 1.6% QoQ, according to last quarter's results.

REVENUE ($ millions)

Periods

2010

2011

2012

March

44

295

559

June

 

392

568

September

81

430

NA

December

172

492

NA

Source: Reuters

The EPS figures also showed a steady increase in the last three quarters. This is an even more encouraging figure for investors, as the primary concern with GRPN has always been its low margins.

EARNINGS PER SHARE ($)

Periods

2010

2011

2012

March

0.027

-0.23791

-0.01816

June

 

-0.177

0.04281

September

-0.07727

-0.01719

 

December

-0.59362

-0.12373

 

Source: Reuters

The increase in margins remains the key to the long term success of GRPN. The company has an EBITD margin of 5.45% and a gross margin of ~80%. The operating margin, however, is almost 50% less than the industry average of 5.03%. The net profit margin is negative, which is why analysts have gone to the extent of calling GRPN a Ponzi scheme. We believe these margins should improve in the long run, as the company improves its ecosystem by offering incentives for partners. These incentives include offers such as Groupon Payments, and the recently launched Breadcrumbs. Breadcrumbs is a POS facility for retailers, starting at $99 a month and offering 24/7 technical support. The biggest item in the income statement, which eats away its revenues, is selling/general/admin expense. In 2011, these expenses formed 98% of the company's total revenues. However, if we compare the last two quarters, revenues have increased by 1.5%, whereas selling/general/admin expenses have gone down by 3%. The most significant decrease has been in marketing expenses, which have decreased by more than 60% in the last quarter, as compared to the same quarter last year.

PROFITABILITY RATIOS

 

Company

Industry

Sector

Gross Margin (TTM)

79.56

25.44

28.8

EBITD Margin

5.45

NA

NA

Operating Margin

3.46

5.03

9.06

Pre-Tax Margin

5.01

4.82

10.09

Net Profit Margin

-2.15

3.14

7.43

Source: Reuters

Conclusion:

We believe investors should expect growth in revenues to continue, as incentives such as Groupon Payments and Breadcrumbs pull retailers into the company's ecosystem. The main culprits eating away the profit are selling and admin expenses, and we believe economies of scales should improve profit because a major chunk of this expense is fixed in nature. Based on this analysis, we believe Groupon will improve its valuation of 14x, and recommend a long position in GRPN.

Source: Buy Groupon: The Valuations Will Improve As Operating Margins Expand