Here’s Why We Have Raised Our Groupon Price Estimate To $7 Per Share

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We have updated our price estimate for Groupon’s (NASDAQ:GRPN) stock from $6.28 to $7.09, following the better-than-expected earnings results in the third quarter. Its key strategies seem to be at last paying off. These include accelerating growth in local businesses served (in North America and other international regions), enhancing profitability in the goods business, and optimizing operations in the international business.  In this light, we think the worst is now behind Groupon. With many of the headwinds pertaining to email declines, redemptions, etc having subsided, we believe the company is poised for growth in the future.

Based on these results, we have updated our outlook for both the top-line and bottom-line, as well. We expect Groupon’s EBITDA margins to show improvement in the coming years as operating leverage should lead to decline in marketing and SG&A (selling, general and administrative) expenses as a percentage of revenue. We have also raised our revenue estimates considering the change in business mix, the acquisition of TMON, and the recent strengthening of local business.

Our $7.09 price estimate for Groupon’s stock, is around 5% below the current market price.

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Profitability Forecast Has Been Revised Upwards

Profitability has been one of the underlying concerns for Groupon’s stock since its IPO in 2011. The company’s GAAP operating margin has varied between -2.6% and 4.5% over the last nine quarters, with an average margin of 1.2%. However, the company is trying to boost its goods margins by taking measures including shifting additional business to drop-ship, adding more fulfillment to its own distribution center, and raising the number of units per order. Additionally, it is standardizing its best practices across the international region to reduce its operating losses.

While we expect Groupon’s gross margins to continue to face pressure due to lower take rates and unfavorable business mix, we have revised our estimates for marketing and SG&A expenses downwards. We believe these operating expenses as a percentage of revenue would see some leverage as revenue growth outpaces increase in expenses. Consequently, we forecast our adjusted EBITDA margin for Groupon to rise from 5.6% in 2014 to 10% by the end of our forecast horizon (2021). As expected, Groupon’s valuation is highly sensitive to its margins — if we raise our EBITDA margin estimate to 12% by 2021, then it would lead to a 15% increase in our valuation.

Revenue Outlook

We have increased Groupon’s top-line forecasts in EMEA (Europe, the Middle East and Africa) and Rest of World. Revenue growth in these regions stood at 40 % and 29 % during the nine months ended September 2014. We have factored in the impact of rising proportion of direct revenues and the acquisition of TMON business in our current forecasts. The company has done well on the mobile platform and its recent initiatives such as Pages and Gnome will further strengthen its business. North American sales are also poised to grow at a healthy rate in the future, given the recent acceleration of local business within the region. Increase in local billings in North America strengthened from 1.8% in Q2 to 10% in Q3, and we expect the company to see a greater than 10% rise in this metric in the coming quarters as well.

We currently forecast Groupon’s revenue to rise from $2.6 billion in 2013 to $7.1 billion in 2021 in our valuation model. In the event, revenue rises much faster to $7.8 billion, then it would represent a 15% increase in our price estimate. We encourage our readers to tweak our estimates to see the impact on valuation.

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