Here’s Why We Have Valued Groupon’s Stock At $7.46

Groupon‘s (NASDAQ:GRPN) stock has seen major weakness in the recent past — it has tumbled by over 35% over the last six months in the wake of analyst downgrades and the exit of the company’s former CFO, Jason Child. Notwithstanding the pressure the company has recently seen on the Wall Street, we continue to remain bullish on Groupon with a price estimate of $7.46, which represents more than a 40% premium to the market price. Though dollar appreciation, macro-economic challenges and slower growth globally are some of the key challenges for the company in the near-term, we expect Groupon to post robust growth over the longer-term time frame. This will be fueled by its expansion on mobile devices, the transition from a push to a pull model, and growth in the number of merchants and inventory on the platform. In our valuation model, we forecast Groupon’s revenue to grow at a CAGR of 10% over our forecast horizon, along with a modest expansion in the company’s EBITDA margins. We highly encourage our readers to tweak our estimates with the widgets below to see the impact on the company’s valuation.

Check out our complete analysis of Groupon

Top-line Is Estimated To Rise From $3.2 Billion In 2014 To $5.8 Billion In 2021

Although Groupon guides to an over-20% increase in sales on the back of a similar rise in gross billings by 2017, we have forecasted its top-line to rise more modestly at 10% CAGR over our forecast horizon. This will be driven by the following strategies:

• Groupon is aggressively focusing on mobile expansion to raise its mobile penetration rates in several international markets. This could help boost the company’s top-line growth, considering mobile users purchase more heavily than traditional PC users.  The annual gross billings for Groupon’s mobile customers purchase more than $70 more than customers who transact only on the web (according to company filings).
• Moreover, the company’s push towards non-email marketing channels (pull strategy) has helped reduce the reliance on traditional email channels. The share of search in the overall North American transactions rose to 27% in Q1 2015, as compared to a mere 9% in Q3 2013. We believe this development is encouraging, since the email strategy by itself is unsustainable in the long-run.
• With new features such as Pages (which carry merchant-related information) and the G.Nome operating system, we expect Groupon’s network of merchants to expand significantly over our forecast horizon. This will directly translate into higher inventory, and thereby faster revenue growth for the company, in our view.
• At the same time, the company is also improving the quality of deals on its marketplace, by adding more national merchants in its network. Although this move will weigh on take rates in the near-term, we expect this strategy to bolster Groupon’s traction among customers in the long-run.
• Regionally, we expect North America to show the highest growth rates in the near-term owing to these strategies. However in the long-run, we also expect robust growth in the EMEA and the rest of the world as well, as there is significant potential for group-buying services in these markets.

Adjusted EBITDA Margin Is Forecast To Increase From 7.9% In 2014 To Around Over 12% By 2021

While Groupon has set a goal for adjusted EBITDA to rise to over 25% in both the near-term as well as coming years, we have estimated its profitability to rise more conservatively over our review period.

• Although Groupon has faced profitability issues in the past, we expect the company’s margins to improve in the coming years supporting by basic operating leverage and efficiency improvements.
• We expect operating leverage in both marketing as well as selling, general and administrative expenses, as the company’s brand image has been well-established across markets.  This could help control the growth in future marketing expenses.
• Moreover, Groupon is pursuing profitability improvement in the goods’ business by moving additional business to drop-ship, enhancing its fulfilment capacity and increasing the number of units per order. The move towards third-party merchants will further push up gross margins in the goods segment.
• Additionally, the company is standardizing its best practices globally, and is exploring strategic alternatives for some of its unprofitable businesses in the Asian region.

Capex estimates, which also significantly impact valuation have been forecast to come down in our valuation model. Expressed as a percentage of revenues, we have estimated capital expenditure to decrease from 2.8% in 2014 to 2.2% in the long-run. All these estimates lead us to believe that the market could be undervaluing the company’s stock at current levels. For the stock to justify current market price in our cash flow model, the company’s EBITDA margin would have to fall from 7.9% in 2014 to 6.4% by 2021 (assuming the same top-line estimates as in $7.46 model). Since we expect the probability of this scenario to be low, we believe Groupon could look attractive to investors at present levels.

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