Groupon’s Shares Plummet On Weak Outlook

Shares of Groupon (NASDAQ:GRPN) have tumbled by over 20% after the company reported disappointing third quarter earnings results and provided weak guidance. While gross billings and active customer growth under-performed expectations, the recent change in Groupon’s leadership also aggravated concerns surrounding the company’s business. With Rich Williams as the new CEO, the company aims to undertake a series of bold measures, such as significantly raising marketing investments, restructuring international portfolio, and moving away from certain low-margin goods businesses. In our view, these strategy changes will not only significantly weigh on both top-line and bottom-line results in the coming quarters, but they also raise doubts about the sustainability of the company’s business model. We think that apart from marketing, Groupon must also work on improving its core product offering to raise its long-term outlook.

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Results Came In Below Expectations

Gross billings, which reflect the amount of customer purchases, rose by 6% globally, in FX-neutral terms, during the third quarter of 2015. While gross billings rose by 12% in North America, they declined by 1% in EMEA, and showed flat growth in the Rest of the World region (all in FX-neutral terms). Active customer growth in the regions of North America, EMEA and the rest of the world was seen at 7%, 3% and -2% annually respectively. In our view, the weak pace of customer growth also leads to doubts regarding the attractiveness of the company’s deals business.

In terms of category-wise growth, services gross billings (which include local and travel services) increased by 4% globally (excluding FX-changes). And the gross margins in this business dropped by 210 basis points year to year to 27.5%, owing to increased discounting on deals. In contrast, shopping gross billings grew by 10% with slight (40 basis year-over-year) improvement in gross margin. We think these results are quite disappointing as the company  under-performed on both top-line as well as bottom-line growth. ^[1]

Drastic Changes In Growth Strategies Raise Doubts About The Sustainability Of Groupon’s Business Model

In addition to the discouraging results, the company also announced a major overhaul of its growth strategies under the new leadership. Rich Williams, who recently replaced Eric Lefkofsky as the CEO of Groupon, aims to undertake three big changes, including: significantly expanding marketing activities, restructuring the asset portfolio (especially international operations), and moving away from certain low-margin goods businesses. In terms of sales and marketing, the company aims to ramp up its spending by $150 million to $200 million annually, taking its average marketing ROI threshold from roughly 6 months to 12-18 months. ^[1] This increased spending will substantially reduce EBITDA margins in the coming quarters.

Within the international operations, Groupon will trim down its portfolio by exiting or selling out its operations in geographies where it sees less chances of establishing market leadership. In September this year, the company had announced its decision to exit from seven markets, laying off 1,100 employees in the process. We expect the company to initiate more such restructuring moves in the coming future.

And within the e-commerce segment, Groupon will move a higher portion of its business to third-parties in the coming quarters. In addition, it will also exit from the low-margin consumer electronics business. All these moves are expected to drastically weigh on both top-line as well as profitability in the near term. While these moves indicate continued challenges in the company’s business model, they also add to concerns regarding its sustainability. Moreover, we think the low profitability and high competition in the group-buying sector, could also reduce expected returns from the planned increase in marketing investments.

We are in the process of revising our $7.51 price estimate for Groupon’s stock

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1. Groupon (GRPN) Rich Williams on Q3 2015 Results – Earnings Call Transcript, Seeking Alpha, November 03, 2015 [↩] [↩]