2023-11-26 07:27:31 ET
Summary
- Groupon's third quarter operating results suggest a slow turnaround for the company, with sequential growth in the units sold and gross billings, that led to a lower decline in revenues.
- The offering caught investors by surprise, and the shares fell significantly below the subscription price. But Pale Fire Capital entered into a binding commitment to backstop the entire offering.
- At the current price, I rate the company as Neutral, until the management shows signs that it's fulfilling the guidance.
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Groupon (GRPN) is a well-known online platform offering discounted deals from merchants to customers in the form of online vouchers. Groupon's online discounts cover three major categories: Local deals (e.g., local restaurants and activities), Goods (e.g., fashion, health, and beauty), and Travel (e.g., hotels and getaways).
The company is serving about 17 million customers worldwide with a TTM gross merchandise value of $1.6 billion and the company's average take rate on the purchase and usage of the vouchers is between 30% and 35%. Meaning, a local hairdresser may normally charge you $50 for a haircut but offers a deal for $40 with a Groupon voucher. Groupon may capture about 30%, or $12, of the price of the voucher and remit $28 to the beauty salon.
The company has become a major turnaround story, as the stock sank about 80% from January 2018 and Pale Fire Capital announced a 5% stake in Groupon that eventually led to CEO Transition in March 2023. Following this transition, the new CEO announced a restructuring plan to cut costs and change internal processes in an attempt to entirely overhaul the business.
Investment Thesis
Groupon has recently reported , in my view, better-than-feared operating results that indicate early signs of a successful turnaround. Namely, sequential growth in the units sold and gross billings that led to a lower decline in revenues. Together with stable profit margins, the company eventually arrived at decent operating results.
In this article, I am going over these important metrics and arguing that this slowdown in the year-over-year decline in key metrics suggests that Pale Fire Capital is slowly turning this company around. The initial drop in share price after earnings was, in my view, an overreaction to the announced offering. Such decline represented, based on my valuation, a favourable risk/reward opportunity to initiate a position. However, at the current price I rate the company as Neutral, until the management shows signs that it's fulfilling the guidance.
Number Of Units Sold
The number of units sold is, in my view, stabilising. Even though the yearly (Y/Y) decline is still significant (-17%), quarterly (Q/Q), the company increased its units sold by 5% which is seasonally higher when compared to prior year.
What's more important is that the key Local category, which contains the main business of Groupon, increased by almost 10% Q/Q. This is the highest increase in several years and suggests that customers found attractive deals. The right mix of merchants and their relevance is a key in my view.
Here is what the CEO commented, on the Q3 earnings call
"We ran a very popular deal in August offered by a large multinational retailer… Experiences like this confirm my view that Groupon is a supply-driven marketplace. If we can get the right assortment on our platform, demand will follow."
We don't know for certain who the multinational retailer was, but I am betting on Walmart with their membership codes or Amazon and their promo codes. Such deals can come to Groupon once or twice a year but I'm reckoning that if this offer was a success the this retailer or a competitor will reach for Groupon more often.
The other two segments are lagging but mainly because the company is de-emphasising the Goods category and because the Travel category is in my view seasonally affected as people bought discounted vacations ahead of summer in Q2.
Third Quarter 2023 Financial Results
Gross Billing
Billing represents the total dollar sum of the units sold. And it is growing faster than the number of units sold. Gross billing decreased 3.5% Y/Y and increased by 6.5% Q/Q. The key Local category increased by almost 11% Q/Q.
This suggests that the customers bought more units with higher price tags. Meaning a successful transition from deeply discounted deals to deals with higher value. You don't see price tags with 90% or 100% discounts on the platform any more and buyers are willing to pay more for higher quality which is what investors want to see.
Third Quarter 2023 Financial Results
Active Customers
Active customers are also falling but at a slower pace. Customers in North America declined by 2% Q/Q and International customers declined by 3% Q/Q. The reason for the decline was an unfavourable product mix, but as it is evident from the graph below, the pace of the slowdown is decreasing. This suggests that the company's strategic changes are starting to have a positive impact. I expect the stabilisation of the firm's active customers to take place in the second half of 2024 based on the strategic changes the company is going through.
In regards of the changes CEO mentioned on the Q3 earnings call:
"For example, one feature we want to provide our customers is a more seamless gifting experience and we believe our new consumer front-end will make it easier to build this new gifting proposition. I would like to have an option to have different pricing conditions, including our take rate for first-time customers and repeated customers. So, the cost for merchants for the second - and - following purchases is different versus what they are paying right now for the first time customers. This is one simple solution, which we will offer to our merchants."
Until the firm's active customers stabilise and begin to strengthen I expect volatility of the share price to continue.
Third Quarter 2023 Financial Results
Revenues
The revenues of Groupon are essentially a percentage of the billings that merchants pay to have their offer displayed. The revenues are down 12% Y/Y and 2% Q/Q which is in contrast with the billings and units sold. This means lower take rate (ratio of Revenues to Billings), which is at 30.2% in the quarter compared to average of 33% in 2022 and 39% in 2024.
The reason is, in my view, the sales mix of products and services with lower margins that are available on the platform. For example, in the 3rd quarter we saw another decline in the Travel category which has higher margins. For Groupon to be successful they need to start selling higher valued services and stop the promotional bleeding.
Third Quarter 2023 Financial Results
Gross Profit Margin
The gross profit margin is stable at 87.5% thanks to their cost cutting initiatives. Pale Fire Capital is searching for more IT professionals in Eastern Europe while cutting positions in the United States. This has lowered wage costs and stock compensations. I believe CEO Senkypl mentioned that they are planning to cut even more merchant-facing jobs reducing them from 1500 to 150 employees.
Third Quarter 2023 Financial Results
The firm also spent less on marketing expenses by 24%. With lower marketing spend, the operating results are therefore decent resulting in the operating loss of $464 thousand which is almost in-line with Groupon's prior guidance.
Third Quarter 2023 Financial Results
I believe the decent operating results with further cost cutting initiatives should have provided a floor for the stock price. However the shares fell almost 35%. I thus believe it's because of the rights offering and not because of the results.
The Offering
I was surprised how strong the reaction was and that the shares fell significantly below the subscription price. Perhaps the offering caught investors by surprise, however it shouldn't have as Groupon announced Form S-3 back in August suggesting that an offering will come.
Also the $80 million doesn't seem like such an amount to me, especially when the major shareholder - Pale Fire Capital entering into a binding commitment to backstop the entire offering. This means that PFC has made a commitment to purchase any unsold shares at a minimum of $11.30 per share.
With the SumUp sale and anticipated cash flow positive Q4 the company doesn't necessarily need the money, in my opinion, to survive. The hidden reason may be to increase their own stake - remember the offering rights cannot be sold so either the shareholders use them at $11.30 or Pale Fire does. In 2020 the board of directors agreed on a "poison pill" to shield Groupon from possible hostile takeover during covid and later PFC agreed not to increase their share over this 25% threshold.
In my view the investors wouldn't pay more when there is a guaranteed buyer at a higher price. Meaning Pale Fire Capital may eventually buy the entire stake and legally increase their share up to 36% (if they buy the entire stake).
Valuation
Based on the company guidance for the fourth quarter and 2024, I came up with the following estimates which are also based on the seasonal trends.
Outlook based on guidance and seasonality (My own custom calculation)
To determine the fair value for Groupon, I rely on the following EV/EBITDA multiple valuation. I take the guidance as the optimistic case; the base-case scenario is going to be 90% of the promised deliveries, and in the pessimistic scenario, 80%. Furthermore, I use a 17% EBITDA margin according to the guidance, and for each of the other cases, I pencil in 1 percentage point less.
At the time of this writing, Groupon is trading at 5.8x fwd EV/EBITDA with the 5-year average at 6x. In my optimistic scenario, I therefore use 6x, which would represent a successful turnaround. The base case is at 5x, meaning a slow turnaround, and the negative scenario at 4x, meaning an unsuccessful turnaround.
As for the SumUp value - In 10-Q , the company states the following:
"our carrying value in other equity investments…which relates to our non-controlling interest in SumUp …. was $93.7 million."
This again is going to be the optimistic case. And for the other cases 80% and 60% of such value, which will represent their ability to monetise the stake.
The current share count is 31.85 mil. at the moment I add 7.07 mil. for the capital raise at the subscription price of $11.30 + I assume additional 1 mil. for stock compensation.
The valuation then comes out as follows…
EV/EBITDA valuation (My calculation)
Risks
Turnarounds are often messy and rarely go as planned, and GRPN is no exception here. On the positive side, a phase of substantive cost cuts is now completed, and GRPN will focus on returning to growth. The latest positive local billings growth is an encouraging proof point.
On the risks side, management is walking a fine line between maintaining the current run rate while also fixing a number of issues in a challenging backdrop environment, and that means project delays and financial results may not turn as quickly as GRPN had initially hoped. Further decline in sales would mean that the company is not able to convert billings into revenues. Also, negative working capital, leading to significant cash burn. And last but not least, the incapability of monetizing their SumUp stake may lead to questioning the management capabilities of Pale Fire or the state of the fintech industry in Europe.
If such risks materialised, I would be inclined towards the pessimistic scenario and abandon my thesis.
Takeaway
Based on the latest results, I think the tide is turning, albeit slowly, and the company is not out of the woods yet. The current stock price of about $10.5 is, based on my model, about fair, and, in my opinion, the management needs to demonstrate that Groupon is capable of fulfilling the guidance before the stock can be rated a strong buy. On the other hand, an inability to deliver the guidance or a general negative macroeconomic development that impacts the consumer could be a negative catalyst for Groupon, and the stock may decline towards the negative scenario. Therefore, it is essential for the company to have the right product mix, especially for the upcoming seasonally strongest Christmas period.
For further details see:
Groupon: The Turnaround Is Slow, But Real