A few weeks ago, I made a very bearish call on Groupon (NASDAQ: GRPN) before its Q3 results. The thesis for the timing of the option play was based on an overall market selloff. While that has not materialized, Groupon none the less is down about 28% since that call. My option play has yielded about 25% if you exit it right now but can yield significantly higher returns if the stock continues to fall over the next few months.
I was discussing this call with a few friends a couple of days back. My argument was that even though this is a low dollar price stock, its high Market Cap (Over $2 Billion as of previous close) meant we were still far away from hitting a bottom. The counter argument I got was that Groupon had close to $690MM in Cash and Cash Equivalents as of Q3 2016 (See line item on balance sheet below) and that gave them a lot of flexibility in orchestrating a turnaround for the company and created significant upside risk for the stock price. In this article I will illustrate why this is far from the truth.
Groupon's Cashflow cycle
A lot of people may be just looking at Groupon's cash position and giving them the benefit of the doubt in executing their turnaround. A cursory look at the balance sheet shows Groupon has cash and cash equivalents of $690MM. The truth is far less rosy. Here is how Groupon's "Group Discount" program works.
1) A user purchases a Groupon on their site. He/She pays by Credit Card/Paypal (NASDAQ: PYPL) etc. These monies immediately go to the line item highlighted below in Groupon's balance sheet.
2) Groupon however still needs to pay the merchant for their service. Groupon creates a Liability on its Balance Sheet and calls it "Accrued merchant and supplier payables" highlighted below.
3) Some time after the campaign ends (see the note from their FAQ below), Groupon pays the merchant their cut of the fee and this item hits the Cashflow statement again as "Accrued merchant and supplier payables"
"Q: When will I get paid?
A: In advance of your campaign, we send you an email entitled "Getting Ready for your Groupon." This message will confirm the payment method you would like to use. We can pay merchants by check or by ACH. Most of our merchants are paid 33% in each of their first two checks, which are sent immediately and about 30 days post-feature, respectively. A third payment, sent at about 60 days post-feature reconciles refunds and refund escrow funds with additional units sold through our Private Sale. Please allow up to ten business days for checks to be processed and arrive at your place of business. "
The slush fund
So the cash position is not really that much of an asset. They need this cash to pay their merchants for the goods/services sold on their site. As of Q3 2016, Groupon had $690MM in Cash and $609MM of Accrued merchant and supplier payables against it. But the story does not end here. Take a look at one of the risks noted in their S1.
"Our operating cash flow and results of operations could be adversely impacted if we change our merchant payment terms or our revenue does not continue to grow.
Our merchant payment terms and revenue growth have provided us with operating cash flow to fund our working capital needs. Our merchant arrangements are generally structured such that we collect cash up front when our customers purchase Groupons and make payments to our merchants at a subsequent date. In North America, we typically pay our merchants in installments within sixty days after the Groupon is sold. In most of our International markets, merchants are not paid until the customer redeems the Groupon. Our accrued merchant payable, which primarily consists of payment obligations to our merchants, has grown, both nominally and as a percentage of revenue, as our revenue has increased, particularly the revenue from our international segment. Our accrued merchant payable balance increased from $4.3 million as of December 31, 2009 to $290.7 million as of March 31, 2011. We use the operating cash flow provided by our merchant payment terms and revenue growth to fund our working capital needs. If we offer our merchants more favorable or accelerated payment terms or our revenue does not continue to grow in the future, our operating cash flow and results of operations could be adversely impacted and we may have to seek alternative financing to fund our working capital needs. "
Essentially they are using the funds they collect from their customers as working capital. Now if you go back to the balance sheet and add in the Accrued expenses and payables net of receivables you are left with a deficit of $220MM. What this means is that if Groupon is not able to keep growing its revenues to pay its merchants and other debts, it will have to in fact raise more money. I won't call it a ponzi scheme but it certainly shares some characteristics.
The End game
So what is the end game here? Some people are keen to point out that Groupon has been successful in select locations. While I have no doubt Groupon can be successful in select markets, is that really a $2-3 Billion dollar opportunity? Google (NASDAQ: GOOG) shut down its "Google Offers" service in March of 2014. Amazon (NASDAQ: AMZN) shut down its "Amazon Local" in December of 2015. LivingSocial which Amazon also had a stake in was sold to Groupon in November of last year for a "Non-material" price. I believe the reason is simple. There just isn't a big enough profitable market for this to get the big boys interested. Recently there was chatter of Alibaba (NYSE: BABA) wanting to buy groupon but it was quickly followed by more rumors that this was not true. While Alibaba did take a 5.6% stake in Groupon in Q4 of 2015, I do not believe they would be interested in taking over the company. If you listen to Jack Ma, he always talks about how Alibaba wants to be the gateway for western brands to sell into the Chinese market, not the other way around. I don't believe Groupon will be bailed out.
At the face of it, Groupon appears to have a lot of cash on hand which can be a good buffer as it plans its turnaround. But if you peel the onion, you realize that its position is far from comfortable. Groupon needs to keep raising new money from customers to pay its past debts. A takeover scenario also looks very remote with most big players having already tried and given up on the business. While the price per share is low, it is still a $2 Billion dollar company because of the large float. The stock price has a long way to fall. Groupon is a sell.
Disclosure: I am/we are short GRPN.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.