Groupon’s (NASDAQ:GRPN) stock has risen from its recent lows due to business model changes and a diversification away from the volatile daily deals market. The most recent drop was caused by the company’s latest earnings release which highlighted the ongoing concerns of its slowing growth. The company also faces macroeconomic headwinds affecting its European business as well as accounting scandals and SEC probes and investor lawsuits.
Nonetheless, it still has opportunities ahead that it’s trying to exploit. The daily deals market is huge and Groupon has a near monopoly in the space. Living Social, its biggest competitor, has gross billings that are a tenth of Groupon’s gross billings. Groupon has also entered the payments space with Groupon Payments and has introduced an iPad based point of sale service to process payments.
We believe the stock is worth $8 and below we explain why.
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- The Key Downside Scenarios For Groupon’s Stock
Groupon Offers Services To Cater To Local Businesses And Merchants
Groupon is predominantly a daily deals site with U.S and international deals making up nearly 85% of its value. The business of daily deals is one with low entry barriers and where competitors who offer better terms to retailers are able to take away market shares from larger players like Groupon.
For now, Groupon has strong networking effects that are acting in its favor due to its large number of registered users, but this may not be a very big deterrent in the long run. To diversify its business, Groupon has rolled out a number of promising tools and services targeted at local businesses. Some of these services are Groupon Now! (a hyper-local location based mobile service), Groupon Scheduler and Groupon Rewards. The company expects to roll out a complete portfolio of marketing and other services eventually for small businesses.
Business Model Changes
- Groupon Payments: Groupon has introduced a credit card processing service for small merchants and businesses at more attractive terms. This makes sense for Groupon as it would enable merchants to merge their vouchers with other payments, thereby reducing transaction costs as well as increasing payment speed. The service charges 1.8% plus 15 cents per transaction for MasterCard, Visa and Discover. For American Express, the company charges 3% plus 15 cents per transaction. 
- Groupon Works: Groupon Works helps small businesses reach a larger audience by providing tools such as a scheduler which helps smaller businesses make reservations and appointments online. It also helps businesses get featured deals on the Groupon website as well as on the mobile application for local deals.
Groupon To Become The OS For Local Commerce
The company launched an iPad based point-of-sale (POS) service for retail establishments and restaurants last week. The service is named Breadcrumb after the POS company it acquired early this year. The service costs $99 per month to authorize one iPad, $199 for two, $299 for five and $399 for up to 10. 
Breadcrumb is fully integrated with GrouponPayments that the company claims to be the lowest cost option for merchants and small businesses accepting credit cards. Apart from being cheaper, the advantage of the payment service is that the merchants will receive credit-card deposits in their bank accounts overnight compared to the usual 2-3 business days offered by most other credit card processing services.
Tapping The High End Restaurant Market
The company has also acquired Savored, a start-up that provides online reservation service for high-end restaurants. It helps fill empty tables by offering deep discounts on meals. Savored has a client base of more than 1,000 restaurants that use its service, and this acquisition will allow Groupon to access the high-end restaurant market as these restaurants are usually hesitant to slash pricing and margins to do a Groupon deal. Apart from the reservation service, Savored also provides a yield management service to help restaurants increase customers at off-peak hours. To book a reservation with Savored, customers pay a reservation fee of $10, and then get up to 40% off of their bills. Restaurants use this service to manage yield during off-peak hours. ((Groupon Acquires Savored, www.forbes.com, Sept 24, 2012))
Dropping Customer Acquisition Costs
Groupon reported marketing expenses of $88 million for Q2 2012, which is less than half of what it paid in the same quarter in the prior year. Groupon has an active user base of 38 million and over 100K unique merchants. If its strong networking effects continue to take root among users, Groupon will be able to acquire customers at a much cheaper rate going forward, and this is likely to contribute to its profitability.
In North America, transactions completed on mobile devices were up 35% y-o-y and nearly a third of all transactions made on Groupon were done on mobile phones. Mobile adoption is key for the growth of new business lines such as Groupon Now which uses mobile phone networks to determine a user’s location and offers deals nearby. Groupon also has entered into a deal with Nokia to show deals on the Nokia Maps platform on the Lumia series. We expect this to be a growth driver in the future.
The European market is the biggest market for Groupon after North America, but the business in the region is suffering due to weak macroeconomic factors. Groupon is also looking to expand into China and other APAC economies. It has already entered the Chinese market through its ownership share in Gaopeng, which recently merged with Tencent-backed firm FTuan. FTuan and Gaopeng are operating in a hyper-competitive Chinese daily deals space as several new players enter the market, trying to cash in on the latest craze. Both players will benefit from cost savings in sourcing, logistics and operations. China is the second largest economy in the world and with a relatively low Internet penetration, the market is bound to grow.
Marketing, Sales and Administrative Costs A Point Of Concern
The biggest factor for the stock’s downside is marketing and selling, general and administrative costs. These expenses haven’t declined much as expected and we will continue to keep an eye on this metric as it is a key indicator of Groupon’s performance.
We currently have a $7.75 Trefis price estimate for Groupon, which stands at nearly 50% above the current market price. Daily deals account for a major portion of its overall value. Groupon competes primarily with LivingSocial backed by Amazon (NASDAQ:AMZN), Google (NASDAQ:GOOG) Offers, Yelp (NYSE:YELP) and countless clones, but it is looking to expand its offerings in other categories to diversify its revenue streams and drive its core daily deals business.Notes: