Groupon Pre-Earnings: Mobile Strategy And Product Innovation Will Help Drive Demand

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Groupon’s (NASDAQ:GRPN) is scheduled to release its Q3 2014 earnings on October 30th. Ongoing concerns over the sustainability of the business have resulted in over 40% drop in the company’s stock price during the year. On one hand, the company is showing impressive growth and its product innovations and mobile strategy pit it strongly against competitors.  But on the other hand, the lack of profitability, increased competition and reliance on a push strategy, have contributed to loss of confidence among the company’s investors.

We expect the company to post strong revenue growth in the third quarter, driven by growth across gross billings and active customer base. Groupon’s mobile strategy and new product innovations (such as time-based deals) will contribute to increased demand in the future. However, in terms of profitability, the company could again disappoint in the third quarter. We expect the margins to decline on an year-over-year basis  in Q3 owing to increase in marketing expenses. Around $24 million in incremental marketing expenses were spent last quarter on order discounts to enhance marketplace adoption and we believe the company will spend a similar amount in the third quarter as well. [1]

Our price estimate for Groupon stands at $6.28, which is slightly above the current market price.

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Recap Of Q2 2014 Results

Groupon saw 23% revenue growth to $751.6 million in Q2 2014, on the back of impressive 29% rise in global gross billings. However, the drop in profitability was the disappointing aspect of the earnings – adjusted EBITDA (a non GAAP measure) was reported at $59.1 million, as compared to $80.5 million in same period a year ago. Acquisitions of Ticket Monster and ideeli, along with an overall rise in marketing expenses, caused the slip in profitability.

The total active customer count rose by 25% year-on-year during the quarter, with North American count rising by an impressive 18%. We expect the customer base to increase by a healthy pace in the third quarter as well.

Rising Mobile Usage And Product Innovation To Drive Demand

Groupon’s mobile strategy has shown promise in the recent past – the growth trajectory of cumulative app downloads has been strong, and the figure crossed 92 million in the second quarter. Mobile accounts for over 50% of Groupon’s business. [1] This bodes well for the company as mobile commerce market is witnessing rapid growth and higher mobile adoption strengthens its position in the local business.

Recently, two new features were launched – Pages and Genome. While Pages creates an online listing for local merchants with useful information (including contact information, maps and reviews), Genome is a new operating system for merchants that allows easier redemption by consumers. Though currently only 5% of the target market of merchants is tied to Groupon, we believe these innovations have the potential to expand its merchant network significantly. Recently, the company also launched time-based deals for establishments that take reservations or appointments. Local restaurants have responded well to this feature, and we expect the uptake for this deal category to rise in the future.

Dependence On ‘Push’ Strategy And Lack Of Profitability Represent Key Barriers

Groupon relies heavily on its Push strategy, which entails sending more than 250 million emails everyday to its subscribers. The user experience generated through this strategy has not been optimal and this has somewhat diluted its brand image and value proposition. Groupon is making efforts to address this issue by encouraging subscribers to search for deals and explore its marketplace (‘pull’) strategy. However, this move has met with only partial success as the share of searches on marketplace as a proportion of Groupon’s traffic in North America increased only slightly from 9% in March 2014 to 10% in June 2014. [1] This implies that email related traffic still comprises for about 90% of the company’s traffic.

Low profitability is another factor that worries investors. Groupon’s GAAP operating margin has varied between -2.6% and 4.5% over the last eight quarters, with an average margin of 1.4%, causing concerns regarding the sustainability of the business model. With competition likely to intensify in the future from the likes of Google Offers and LivingSocial , we think it will be tougher for Groupon to gain bargaining leverage in the industry, and this could weigh on its future profitability as well.

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Notes:
  1. Groupon’s (GRPN) CEO Eric Lefkofsky on Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, August 5, 2014 [] [] []