Groupon Misses On Top-Line, But Beats On Profitability In Q1

Groupon (NASDAQ:GRPN) posted top-line of $750.4 million in Q1 2015, which came in below market expectations. Excluding currency headwinds, the revenue growth was higher at 10%, driven by increased demand across the North American and EMEA region. In addition, the company beat on profitability with adjusted EBITDA and non-GAAP EPS coming in at $72.4 million and $0.03, respectively. Going forward, we believe currency headwinds, macro-economic challenges, and slower growth in the rest of the world geography could continue to impact the company’s top-line. On the other hand, margins could improve in the coming quarters owing to efficiency improvements and operating leverage. However, increased investments in its pull strategy (order discounts), the addition of higher quality merchants, and a greater share of goods’ business in the overall mix will somewhat drag earnings growth in the future, in our view.

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Strong North American Results Carried Earnings

In North America, Groupon posted strong growth with 14% and 11% annual increases in gross billings and revenue, respectively. This was driven by broad-based growth across the local, goods and travel businesses. Local gross billings in the region showed continued double-digit growth at 12%, as the company’s initiatives to drive the pull marketplace and improve the quality of deals yielded positive results. Though the take rate in the local business showed 110 basis point sequential improvement to 35.3% in Q1, we expect take rates to persist at around 35% in the North American local business over the coming quarters. This is because the company continues to add lower take-rate, higher quality merchants in its network.

Encouragingly, operating income in the North American segment showed 117% year-over-year increase to $25 million. Goods gross margin (as a percentage of gross billings) in North America rose by 320 basis points annually to 8.4%. We expect these goods gross margins to keep increasing in the near future, as the company is taking various initiatives to lower its shipping and fulfillment costs. The addition of third-party merchants in the overall goods business will further contribute to higher margins in the future.

Results in the EMEA region were impacted by macroeconomic challenges and currency headwinds. Though gross billings and revenue declined by 11% and 6%, respectively, in dollar terms in EMEA, these metrics increased by 7% and 13%, respectively, in currency-neutral terms. We expect the demand to accelerate in this region in the coming quarters, especially in the local business. Finally, within the rest of the world geography, the company saw 1% and 8% declines in gross billings and revenue, respectively, on a currency-neutral basis (in continuing operations). We expect operating profits in this segment to near break-even in the coming quarters driven by ongoing efficiency improvements in the region. Groupon’s management continues to explore strategic alternatives for some of these regional operations, and hence we could see some more divestitures in the future.

Groupon Is Focusing On ‘Push To Pull’ Strategy And Merchant Expansion To Accelerate Growth

Though Groupon began with a push-only business model, where it used to send hundreds of millions of emails everyday to customers, it has been heavily focusing on driving its pull marketplace (where customers search for deals) over the past few years. These efforts are bearing fruit as the share of search in the overall North American transactions increased to 27% in Q1 2015 as compared to 20% a year ago. With continued investments in active deals and order discounts, we expect this share to further increase in the future. Simultaneously, we also expect the email business to see some growth in the future.

Merchant expansion is another area of long-term growth for Groupon, considering less than 5% of the target market of merchants is presently tied to the company. More than 900,000 merchants pages, which carry valuable information (such as contact information, maps, and reviews) have now been released publicly, and these are driving higher traffic and engagement levels on the platform. Moreover, Groupon is also optimizing its merchant-facing operating system to enhance its value proposition and customer experience. We will continue to closely track the progress of these initiatives in the future. In an earlier article, we had highlighted that in the event Groupon’s active merchant count increases to 1.3 million over the long run, instead of our present 900k estimate, it would represent more than 25% increase in our price estimate.

We are in the process of revising our $8.01 price estimate for Groupon’s stock.

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