Groupon is currently the world’s largest collective-buying platform and plans on pricing its IPO Thursday afternoon and start trading on Friday. The company started in November 2008 as part of The Point, an online community launched in 2007. Groupon features daily deals for various restaurants, spas and other businesses in over 175 North American markets and 45 countries worldwide. These offers are available to the company’s impressive +140 million strong subscriber base. Groupon competes with other daily deal providers such as Google (NASDAQ:GOOG) Offers, Living Social and a host of others across the globe.
We launched coverage of Groupon with a $7.9 billion valuation estimate based on our discounted cash flow analysis. While its past growth is impressive, we believe that growth will slow down as it penetrates major markets in N. America and as competition intensifies.
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Groupon at a Glance
The company has demonstrated an aggressive expansion strategy driven by acquisitions and partnerships across the globe that has led to its monumental top line growth. Revenues have increased from around $15 million in 2009 to over $1.1 billion for the first three quarters of 2011. The company has increased the number of participating merchants to almost 80,000 since its inception and sold around 33 million Groupons in the third quarter alone. Its headcount has expanded from 37 employees to 10,418 by the end of the third quarter.
As reported in the company’s IPO filing, its strategy going forward is to: 1) grow the subscriber base, 2) grow the number of merchants and 3) increase the number and variety of products through innovation. This planned expansion is the need for additional capital and why the company is floating its shares to the public.
North American Deals are 55% of Groupon’s Value
We have broken down our analysis of Groupon into 5 divisions and briefly highlight some of the key drivers within these divisions.
- North America Featured Deals
- International Featured Deals
- Groupon Now
- Groupon Getaways
Groupon’s Value-Add for Certain Businesses
While some critics have cast doubts over the the sustainability of the firm’s business model, Groupon promotions can be a better alternative to traditional advertising for certain types of businesses.
According to a study conducted by Rice University, 70% of service businesses such as health clubs, spas and yoga centers actually made money after running a Groupon deal.  This falls in sharp contrast to restaurants where only around 44% of surveyed merchants profited financially through the use of Groupons.
The primary reason for the discrepancy is that the marginal cost incurred by the merchant for every new customer is lower for some businesses vs. others. For example, for yoga classes, there is essentially no added cost for adding another person to a class. However, tangible products such as food service that have very low gross margins might find a daily deal like a Groupon to be a losing initiative for them. Some business owners simply chalk this up to additional advertising costs.
North America Featured Deals
Groupon’s North American featured deal business is the flagship segment for the company, constituting over 50% of the company’s value by our estimates. Groupon has enjoyed extraordinary revenue growth for this division, driven primarily by a surge in the number of Groupon subscribers.
However, Groupon’s business model has been challenged in some mature markets such as Boston and Chicago. Competition in the social commerce space has surged and many users experience “daily deal fatigue.” As a result, revenue growth will slow down for the company as it penetrates most major markets and faces more competition.
The high costs of customer acquisition that Groupon is incurring will eventually force the firm to strike a balance between aggressive expansion and customer & merchant retention if it plans to move forward its profitability. Moreover, it will need to prove its ability to defend its business model by distinguishing itself as a leading provider of deals for the best merchants.
Potential Stumbling Blocks May Surface
Apart from defending its core business model, the company could face some issues as it grows. One challenge could be growth internationally. Another more pressing issue surrounds the law regarding deal promotions.
Many critics allege that Groupon is ultimately selling gift certificates at the end of the day. In most U.S. states, gift certificates – which are essentially shopping vouchers – are not supposed to expire. In some extreme cases, the minimum expiration date stands at over 5 years. Many customers have complained that some of their Groupons expire before they have a chance to use them making them feel like they were hoodwinked, and this could lead to greater scrutiny by city and state authorities. Groupon is currently facing legal scrutiny in many U.S. states for alleged gift card violations, and any action taken by regulators could hold repercussions for other markets.
While we are impressed by Groupon’s growth and acknowledge that its core business model of offering daily deals to subscribers makes sense, the rumored preliminary IPO pricing range of $10-11 billion looks a bit expensive based on the fundamentals we see.Notes: