Why Are Groupon Subscribers Buying Fewer Deals?

Groupon’s (NASDAQ:GRPN) stock has fallen significantly since its IPO, and we believe that the fundamentals still don’t justify its current market price. After posting stellar growth in the last few years, we expect the company’s revenues to peak in the next couple of years and eventually decline as we believe that the long term growth may not be sustainable. The number of Groupons sold per subscriber are declining, and this is one of the key risks that the company faces. The figure for North American region has slumped from estimated 1.97 in 2010 to about 1.41 in 2012 primarily due to a host of competitors springing up as the barriers to entry are rather low. We expect this trend to continue and forecast the number of Groupons sold per subscriber to fall below 1 in the next few years. Let’s take a look at what will drive this decline.

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Negative Consequences For Local Businesses

While Groupon claims that more than 90% of businesses that are featured ask to be featured again, many businesses often find Groupon to be a loss making proposition for them. They don’t tend to break even in terms of costs, and the lack of repeat customers and additional sales makes it difficult for businesses to operate. According to a study conducted by Rice University, Groupon promotions were not profitable for 32% of the businesses with 40% of the respondents indicating that they would not run a similar promotion. As long as Groupon keeps its gross margins (the commission it earns over every Groupon) as high as they are currently, there will be a sizable number of merchants who will continue to remain unprofitable, especially those in the products based businesses. This effectively means difficult merchant relationships and a decline in the number of Groupons sold for every subscriber.

Groupon’s Business Model Is Deteriorating In Its Mature Markets

A closer inspection of Groupon’s case studies available in its SEC filings reveals that the company’s business model is not working as planned, especially in its mature markets. Net deal revenue per subscriber in North America has shown a steady decline with the figure coming down from an estimated $22.40 in 2009 to about $14.20 in 2012. This suggests that while Groupon is showing an ever increasing subscriber base and top line growth, it has not managed to successfully retain those subscribers to buy more Groupons in future. This is a worrying sign for the company as once its acquisition spree ends, declining revenue per subscriber trends would start showing up in its other markets as well.

Groupon’s business model is easily copyable and customers are looking for cheaper deals no matter where they come from. The loyalty towards the company is a result of the quality of deals and discounts it is able to offer. Therefore, we don’t expect subscriber engagement levels to be particularly high for Groupon daily deals compared to other competitors such as LivingSocial. Even if Groupon continues to build its scale, it can not guarantee that its subscribers will keep buying Groupons at the same rates.

Strong Competition In The Discounted Deals Space

It is estimated that there are over 200 social buying site clones in the U.S. itself and over 500 worldwide. Low barriers to entry and start up costs have given rise to a number of competitors in this space. Several of these sites have been backed by big venture capital funds. While BuyWithMe has been backed by Bain Capital Venture and Matrix Partners, TownHog has received funding from D.E. Shaw. Some sites offer additional incentives such as increased discounts as more people sign up (example – eWinWin). Living Social offers customers a free deal if they are able to persuade three other people to buy it.

Our price estimate for Groupon stands at $5, implying a discount of about 40% to the marker price.

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