Groupon Posts Strong Holiday Season Sales, But Future Outlook Looks Soft

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Groupon (NASDAQ:GRPN) posted top-line growth of 20% to $925.4 million in Q4, which came in ahead of market expectations. Strong growth across all geographies and business categories caused 31% increase in total gross billings during the quarter. The 4% expansion in gross profit was partially offset by high investments due to the Ticket Monster (Tmon) and ideel acquisitions, as well as currency headwinds. We expect the company’s growth in the coming quarters to be driven by addition of more deals and higher-quality merchants to its marketplace, an improvement in customer experience, and the optimization of its pull strategy.

Groupon’s management guided revenue growth to be in the range of 4% to 11% during Q1 2015, which we think is comparatively soft.  It reflects both adverse impact from currency headwinds and lapping of Tmon and ideel acquisitions.The company aims to grow its adjusted EBITDA by over 25% in 2015, powered by its initiatives of improving profitability in goods and international businesses.  However, we believe several factors could limit Groupon’s margin increase in the future. including an  increased share of goods’ business in overall mix, the addition of higher quality lower take-rate merchants, and increasing investments in pull marketplace and its growth strategy.

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Profitability Initiatives Are Paying Off

Groupon’s adjusted EBITDA came in at $87.0 million in Q4 2014, as compared to $72.0 million in a similar period a year ago. The discount deals company continued to gain traction against its strategic initiatives of increasing margins in the goods’ and international businesses. Despite seasonality issues in Q4, as the holiday season is characterized by heavy discounts and promotions, goods’ gross margins (as a percentage of gross billings) within North America stayed north of 9%, and witnessed year-over-year improvement of 190 basis points. We expect these margins to continue to show an upward trend in the coming quarters as the company is shifting additional business to drop-ship, increasing its fulfillment capacity and raising the number of units per order.

Moreover profitability in the international business, which has been an area of concern, is showing signs of improvement. Excluding Tmon, the rest of the world delivered a $12 million improvement in operating loss during the fourth quarter. [1] The Tmon business contributed for around $13 million of the overall $16.2 million operating loss in the rest of the world geography in Q4, as Groupon made additional investments in this business to accelerate growth in an increasingly competitive environment. While Groupon’s management is exploring strategic and financing options for Tmon, more details were not divulged on this development.

Progress Reported Against Growth Initiatives

Groupon also reported progress against the rollout of its two new features (Pages and Gnome) during the fourth quarter results. As expected, this is helping drive additional engagement and traffic on its platform. Pages help local merchants set up an online identity with useful information (such as contact information, maps and reviews). The company has now released more than 800,000 such pages publicly for search engines to index, as compared to 500,000 at the end of Q3. In addition, the Gnome operating system, which connects merchants with Groupon’s platform in real-time, was expanded across a larger network of merchants. We believe this strategy is promising, as these initiatives will not only improve user experience, but will also help in the expansion of the merchant and customer base in the long-run.

The company plans to lay strong emphasis on time-based deals in 2015, which represents a deal category that could gain high popularity among merchants, in our view. Additionally, Groupon aims to add more higher-quality merchants in its network. While the take rates in the North American local business were earlier forecast in the 35-38% range, it now seems that the figure will fall at the lower end of this guidance range during the next few quarters.

Broad-Based Growth Seen Across Business Units

Overall gross billings rose by 31% year over year during the fourth quarter, driven by 8%, 60% and 40% growth, rspectively, in the local, goods and travel businesses. Significantly, North American local gross billings rose by 14% annually, which represented acceleration in growth from the region. The company should continue to see high demand in the North American local business in the coming future, in our view,  as the major headwinds related to email decline and redemptions subside. Further, the goods’ business was propelled by growth in direct sales, and solid demand in the Tmon business.

In terms of geographic results, gross billings (in currency neutral terms) rose by 20%, 8% and 154%, respectively, in North America, EMEA and rest of world. Excluding Korean operations (which includes Tmon), rest of world billings grew by 6%. An increase in marketing expenses and order discounts, which grew by $39 million year-over-year in Q4, was partly responsible for this strong billings growth. [1] We expect these marketing-related expenses and discounts to stay high in the near-term, as they help in driving awareness and adoption of pull marketplace.

We are in the process of revising our $7.09 price estimate for Groupon’s stock.

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Notes:
  1. Groupon’s (GRPN) CEO Eric Lefkofsky on Q4 2014 Results – Earnings Call Transcript, Seeking Alpha, February 12, 2015 [] []