Here Are Some Key Triggers For Groupon’s Stock

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Groupon

Groupon (NASDAQ:GRPN) has set ambitious long-term growth targets, as it aims to grow its revenue and adjusted EBITDA by more than 20% and 25% by 2017. In order to accomplish these goals, the company aims to significantly expand its merchant network and move towards non-email based marketing strategies to increase its traction among customers globally. We believe more-than-anticipated success in these strategies could hold huge upside for the company’s stock, assuming the market prices in these plausible developments correctly. In addition, Groupon is also taking aggressive measures to enhance its goods margins in North America. We believe developments in this regard could lead to certain events that could trigger stock price changes for better or worse. So we assess three specific scenarios below: 1) an increase in the active merchant count to 1.3 million; 2) an increase  in monthly unique visitors to 450 million; and, 3) goods margins remain unchanged.

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Check out our complete analysis of Groupon

Active Merchant Count Rises To 1.3 Million (+30%): Groupon is taking various measures to expand its merchant network and inventory, considering it has been able to tie up with only around 2% of the target market of merchants (in core categories) presently. Since over 800,000 merchants have been featured on Groupon from its inception up to September 2014, we estimate the entire merchant opportunity at over 40 million. It has introduced new features, including Pages and G.Nome to help in this direction. More than 800,000 pages were launched last year; these provide useful information (including contact information, maps and reviews) and also allow customers to follow merchants, request deals and make appointments. Moreover, seven million more such pages are expected to be released soon in the coming months. The G.Nome operating system provides various features such as item-level sales, analytics and seamless redemption for customers, and connects merchants in real-time to Groupon’s systems. The company has also lowered its take rate for larger merchants to bolster deal quality on its marketplace.

To roughly estimate the impact of merchant expansion on gross billings, we note that  Groupon achieved overall gross billings of $7.58 billion in 2014 on the back of around 300k active merchants during the year. This implies average gross billings per active merchant stood at around $25k during 2014. If we forecast the long-term average gross billings per active merchant at around $16.5k (considering the possibility of newer merchants being not as active on the platform, coupled with international growth, where transaction values are lower), we estimate active merchant count to triple to around 900k in our $8.01 price estimate, on account of the above given initiatives. However, in the event, Groupon is able to expand its active merchant network significantly to over 1.3 million active merchants by the end of our review period, then it would lead to over 30% upside in our price estimate. We believe this could be a plausible scenario, owing to factors including: 1) rapid growth in subscribers on Groupon’s platform making it highly attractive for merchants, 2) a more than anticipated reduction in take rates due to increase in competition, and 3) the introduction of innovative deal categories that allow merchants to sell unused inventory.

Monthly Unique Visitors Increases To 450 Million (+20%): Though Groupon began with a push-only strategy, which entailed sending hundreds of millions of emails daily to customers, the company has been making efforts to expand into non-email channels over the past few years. This strategy has showed some success, as the share of emails in North America’s local business reduced from 48% in Q4 2011 to 22% in Q3 2014. At the same time, the contribution of non-email business has grown from 52% to 78%. The ‘Pull’ strategy, which encompasses active search for deals, has gained traction, as its share in North American transactions increased from 9% in Q3 2013 to 24% in Q3 2014.

To approximate the potential upside/downside of this strategy, we note that Groupon  saw around 150 million monthly unique visitors globally during 2014, on top of which, it recorded $7.58 billion in gross billings. This translates into average gross billings of about $47 per monthly unique visitor currently. We estimate this metric to fall to around $40 in the long-run, due to growth in international markets, where consumer spending power is lower. Owing to these estimates, we believe monthly unique visitors on Groupon could surpass 370 million by the end of our forecast horizon. However, if the number of monthly unique visitors outpaces our expectation and rises to 450 million by 2021, then it will lead to over 20% increase in the company’s value. There are reasonable grounds to consider this as a plausible scenario, such as: 1) a  large rise in deals and goods inventory should bolster Groupon’s popularity and usage among users worldwide; 2) success with Pages strategy will directly translate into more users searching the site; and, 3) deals from larger (and more popular) merchants will improve the stickiness of the platform.

Goods’ Margins Stay Constant In North America (-10%): Groupon’s lack of profitability has been a key area of concern for the company’s investors. Its GAAP operating margin has declined over the past few years from 4.2% in 2012 to 2.9% in 2013 and -0.5% in 2014. The increasing proportion of the goods’ business in the overall mix, coupled with its low margins has been one of the primary reasons for this drop. Gross profit as a percentage of gross billings stood at 10.2% in the goods business in 2014, as compared to 30.9% and 15.3% in local and travel businesses respectively. At the same time, the share of goods billings in the overall company’s gross billings has risen from 28% in 2012 to 41% in 2014.

Groupon’s shipping and fulfillment costs historically have been double compared to other bigger e-commerce companies. As a result, the company is taking initiatives to improve goods’ gross margins (mainly in North America) by shifting additional business to drop-ship status, adding more fulfillment to its own distribution center, and increasing the number of units per order. In the long-term, Groupon aims at goods gross margin (as a % of gross billings) at about 15% in North America, as compared to around 10% presently.

In our valuation model, we estimate the goods’ category will comprise  about half of Groupon’s overall business in North America (in terms of gross billings) in the long-run. Further, we have forecast long-term gross margin in North America’s local, goods and travel category at about 32.5%, 15% and 17% respectively in our price estimate. Hence, these forecasts lead us to conclude that Groupon’s North America gross margin could come down from 42.4% in 2014 to around 34% in the long-run (due to the increasing share of goods’ in the overall mix). In the event, goods’ gross margin in North America stays similar to current levels over our forecast period, then the overall North America gross margin could decline to less than 30%, leading to about 10% decline in our price estimate. We think there is some likelihood of this scenario taking place, considering there is intense competition in the North American e-commerce market, which is only expected to become worse with the entry of brick-and- mortar retail giants. This will play out in terms of price-based competition, and could result in reduction in shipping charges.

Our $8.01 price estimate for Groupon’s stock, is approximately 5% above the current market price.

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