Groupon Sinks On Lowered Guidance And Falling Margins

Deals and discounts site, Groupon‘s (NASDAQ:GRPN) stock took a beating after the announcement of its Q4 and FY 2012 results on February 27. The stock lost nearly 25% in early trading Thursday and is currently trading at slightly lower than $4.50. The stock fell mainly due to lower guidance provided for Q1 2013, and the fact that its changing business model and reliance on Groupon Goods has lowered its margins. Groupon’s margins are much lower in Q4 around and its cost of revenue has nearly tripled y-o-y, due to its new business line Groupon Goods and due to the fact that it is selling more expensive deals. The total cost of revenue was higher from $260 million in 2011 to $720 million in 2012, while revenue grew at a much slower pace from $1.6 billion to $2.3 billion.

However, there were some positive numbers in this quarter filing. The deal inventory nearly quadrupled in 2012 and went up to 37,000 by the end of 2012, up from 10,000 in 2011. While the North American business showed strong growth, the European business continued to decline. We examine some key trends to the deals business below.

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Low Gross Margins And Falling Revenue Per Customer Are Something To Worry About

The deals business has traditionally been a high gross margin business, but with more competition and Groupon’s efforts to tweak its business model, this has led to lower margins. This is evidenced from the fact that gross margins fell steeply in 2012 to 69%, when compared to 83% in 2011. We expect to see margins improve slightly as the payments and point of sale (POS) business ramps up.

While the North America business continues to improve, it is being offset by weakness in the international business as Groupon experienced a trailing 12 month billings per average active customer of $144, a decline of 23% y-o-y and 3% q-o-q on a global basis. This is a worrying trend that investors should keep an eye on.

Highlights And Outlook

The biggest challenge for Groupon is its international business which grew 20% y-o-y to $1.16 billion. North American revenues grew by 83% y-o-y and also reached $1.16 billion while marketing expenses dropped by nearly 60% y-o-y to $337 million.

While its customer acquisition costs have dropped significantly, the SG&A costs have gone up by 50% y-o-y to $1.06 billion, and we will keep an eye on this metric in the coming quarters. The dropping marketing expenses suggests that the brand is becoming stronger with its customers, but these gains are being eroded by the climbing SG&A expenses.

Groupon also released an outlook for Q1 2013 and expects revenue to be between $560 to $610 million, a decrease of 20% q-o-q. Income from operations for Q1 2013 is expected to be between -$10 to $10 million. As it streamlines its international business along the lines of its North American business, we can expect revenues to grow.

We currently have a $3.20 Trefis price estimate for Groupon, which stands nearly 40% below its current market price.

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