Groupon’s (NASDAQ:GRPN) journey to going public has been bumpy to say the least. After a slew of PR mishaps, some questionable accounting practices and some highly-publicized merchant fall-outs, the company’s stock finally ended 2011 at a price slightly less than its $20 offering price. While Groupon can become a sustainable business, we believe that its present fundamentals do not support the stock’s current market price. Groupon leads the daily deal market and shares this space with players such as LivingSocial and Google (NASDAQ:GOOG) Offers.
See our full analysis for Groupon
Polarized Expert Views Have Contributed to Volatility
Groupon’s touted valuations have fluctuated wildly in the past, and investor views continue to be polarized. Many industry experts have cited that Groupon’s business model is doomed to fail, especially in the wake of intense competition and the entry of large players like Google. On the flipside, many have bought Groupon’s revenue blitzkreig story, reiterating Eric Lefkofsky’s view of Groupon being “wildly profitable”. Both these views have garnered enough press, and this has left the retail investor in a limbo as to where exactly Groupon stands.
Groupon Still Going for High Marginal Cost Merchants
While consumers are always happy to jump on the cheapest deal, Groupon’s main problem arises from its merchants. Surveys conducted in the recent past have yielded a mixed bag, with the recent one stating that merchant demand is expected to reduce in the next 6 months. While this debate rages on, the most visible trend is that merchants with high marginal costs (for instance, food & beverage businesses) are bearing the brunt. After Groupon’s deals led to a hefty loss for a bakery, another food business was liquidated in January 2012 after running heavy losses from a Groupon deal. [1] In contrast, there have been no reports of service-dominated businesses like spas being adversely affected by a daily deal scheme.
Food & drinks still constitute around 24% of Groupon’s total deal mix in North America, and it would not be a surprise if more such incidents crop up in 2012.
Groupon urgently needs to get its merchant mix right, focusing more on service-based businesses that will tangibly benefit from daily deals. Merchants also seem to be relatively unaware of the risks involved in running a daily deal, and Groupon must highlight these risks before striking a deal. The company may also need to compromise on the sales pressure it puts on merchants as more small businesses failing simply means more bad PR for Groupon.
Source: Groupon's S-1 Filing Dated 1st November 2011
Take Rates to Come Down
Groupon’s take rate was little over 40% for its daily deal business in 2010 and 2011, and we expect this to decline to around 30% by the end of Trefis forecast period. The primary factor behind this is intense competition in the space, especially from tech giants like Google and Amazon. Such companies have sufficient cash cushion through their primary businesses, (e.g. search advertising for Google) that enables them to give more payouts to merchants.
Further, Groupon cannot continue with its marketing blitz forever, with marketing expenses at around $613 million for the first nine months of 2011 (around 55% of its net revenues for the period). [2] This means that to get more subscribers it needs to strike partnerships, a recent one being with Deutche Telekom. [3] As partners command their own revenue share, Groupon’s take rates are bound to decline. Take rates are a crucial driver in determining Groupon’s stock. In fact, to achieve $20 stock price, Groupon’s daily deals take rate would have to increase to close to 60% by the end of Trefis forecast period.
We recently launched coverage of Groupon with a $13 price estimate. Refer our note on why Groupon’s valuation has fluctuated significantly over the past 2 years.
Understand How a Company’s Products Impact its Stock Price at Trefis
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