Summary
- Back in 2010, Groupon rejected a $5.75 billion deal from Google, and the company is now valued at just over $300 million in the market.
- To evaluate GRPN's prospects, investors need to look closely at the new business model of the company while identifying potential threats that could permanently impair its profitability.
- Groupon's focus on local experiences seems the right way to move forward but there is a lot of uncertainty.
If investing in stocks was as easy as identifying cheaply valued companies, I bet it would be tough to lose money in the market. More often than not, companies are cheaply valued for a reason, but every now and again, we come across companies that are irrationally valued in the market. In my first article on Groupon, Inc. ( GRPN ) published nearly a year ago, I claimed that Groupon was undervalued. Still, I was forced to wait on the sidelines as I could not identify any catalysts that could drive the stock price higher in the foreseeable future. In other words, I thought Groupon was cheaply valued for a reason. With Groupon stock price halved since then, the time is right to re-evaluate the prospects for this once-popular Internet company to determine whether GRPN is irrationally valued in the market today.
Groupon - Stuck between a rock and a hard place
Groupon, when it first emerged more than a decade ago, was an instant success. Less than two years since its inception, in 2010, Alphabet Inc ( GOOG , [[GOOGL]]) ("Google") offered to buy Groupon for a staggering $5.75 billion, a deal that did not go through. An excerpt from the book Groupon's Biggest Deal Ever by Frank Sennett published by WTTW in 2012 suggests there were three reasons behind the failure of this deal:
- The breakup fee of $800 million offered by Google was apparently not sufficient to convince major shareholders and the company management as there was a lot of regulatory uncertainty surrounding this deal (remember, Groupon was a hot tech company back then).
- Major shareholders believed Groupon had a long runway for growth.
- Nitin Sharma, a highly regarded researcher who had just joined the company, highlighted in a presentation that the company could grow tenfold by optimizing its data analytics process.
Fast forward to today, and Groupon is not even worth the breakup fee offered by Google back then at a market capitalization now of just over $300 million. However, Groupon indeed proved itself correct in the short run when the company debuted on Nasdaq at a valuation of $12.7 billion in 2011. The party, however, did not last long.
Today, the company is well and truly struggling to make the profits the management once thought were possible. Before we discuss what the company hypothetically needs to do to revive growth, let's look at a few key stats from the most recent quarter to understand the ongoing struggles faced by Groupon.
- Total revenue declined a staggering 42%.
- Purchasing frequency of North American customers declined by 23%.
- Local and travel revenue declined by 28%.
- International segment local and travel revenue declined by 19%.
- International goods revenue declined by 91% (this is understandable because of the company's efforts to reorganize the business).
To put it shortly, nothing seems to be going right for the company except for the reduction in operating losses reported for the second quarter. A quick look at the below chart reveals how Groupon's revenue has fallen off a cliff in the last 5 years while the company continued to book losses.
Groupon revenue and net income
At the risk of leaning on the overly optimistic side, let me also highlight that the massive decline in revenue has not necessarily translated into higher losses in the recent past thanks to the cost-reduction measures introduced by the company and the pivot to the local experiences marketplace model. For Groupon stock to recover from these lows, however, the financial performance needs to improve notably. For this to happen, I believe the company would have to spend a much higher proportion of its revenue on marketing. The problem with such a strategy is that Groupon's profit margins will undeniably decline if the marketing budget were to be ramped up. In other words, I believe Groupon will not be able to meaningfully grow without sacrificing its margins, which are just hanging above the water today.
Groupon's business model does not allow the company to gain any competitive advantages either, since many customers, including yours truly, can and will use Groupon every now and then rather than very frequently. This means customer acquisition costs will always remain high for Groupon. Although its daily deals created a buzz among consumers back in the day, there are many deal websites available today with merchants increasingly targeting customers directly. These dynamics, in my opinion, suggest Groupon will face an uphill battle to grow revenue while expanding margins.
A business model with potential flaws
Small and local businesses can use Groupon to run profit-driven online marketing campaigns. Groupon will make money through these partnerships as the company takes a cut from the revenue generated from these campaigns. The challenges Groupon faces come to light in the next step. Many of these small businesses use a variety of tools including e-mail marketing and cold calling to turn customers who found them on Groupon into regular customers, and eventually, many of these small businesses run their marketing campaigns on their own without using Groupon deals. For this reason, Groupon has consistently failed to form satisfactory long-term partnerships with businesses, which in return has led to higher customer acquisition costs and depressed operating margins.
More than an e-commerce platform, businesses still view Groupon as a short-term marketing tool to reach a high number of potential customers in a limited time. Even at the onset of entering into a partnership with Groupon, many businesses do not intend to use Groupon in the long run to reach their potential customers.
If we look at the most successful businesses in the world today, the most common characteristic that stands out is the recurring revenue streams generated by these businesses that enable them to monetize their customers/subscribers better. For Groupon, unfortunately, things have not worked out the same way, and I doubt whether this will change anytime soon given its business model. Groupon has tried its hand at several other business lines including Groupon Goods which failed due to intense competition from well-established online marketplaces such as Amazon.com, Inc. ( AMZN ) and eBay, Inc. ( EBAY ).
There is still hope
Whatever hope I have for Groupon stems from the distant yet realistic probability of Groupon becoming the go-to marketplace for consumers looking for local experiences. Similar to how Amazon specializes in products and Airbnb, Inc. ( ABNB ) specializes in finding stays, Groupon could become the platform of choice for consumers looking for local experiences such as leisure activities and sightseeing. Groupon, in my opinion, has finally picked a niche that they could possibly dominate in the long run, but the company still needs to go a long way to achieve this objective. With a carefully crafted inventory of deals on experiences, Groupon may be able to carve out competitive advantages in the long run, but it's too early in my opinion to invest in GRPN stock based on this expectation.
Takeaway
Groupon continues to lose ground, but all hope is not lost as the company could emerge as a true market leader in the local experiences category. Although I am not comfortable with betting on Groupon's future purely based on the fact that the company has taken a right turn, I will continue to monitor Groupon's progress closely, as a successful turnaround will likely result in multibagger returns.
For further details see:
Groupon: All Hope Is Not Lost But The Future Is Hanging By A Thread