Groupon’s (NASDAQ:GRPN) second quarter results were encouraging as its operating profit climbed due to strong growth in North America and a rebound in gross billings in the EMEA region. While this suggests that the situation might be improving, the company still has a long way to go before it can truly convince the investors that its business is sustainable. Asia-Pacific and Latin American markets are still weighing on Groupon’s growth. One of the ways that the company can build upon its existing strategies and stabilize its business is by diversifying into selling physical goods similar to what Amazon (NASDAQ:AMZN) does.
Groupon is planning to invest in building a warehouse network that will allow it to ship physical goods to its customers directly instead of relying on its merchants.  Besides improving the delivery time, this move will aid the company’s margins. However, the capital expenditures could be high and there will be pressure on Groupon’s cash flows in the near term. Groupon has mentioned that it intends to sell some specific items at best possible price, and isn’t interested in selling everything just yet. 
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It Makes Sense For Groupon To Expand To Physical Goods Business
Although Groupon’s deals business has crumbled in international markets, the silver lining is that the brand is recognized globally. The company can leverage its large user base to successfully expand its physical goods retailing business. There is plenty of opportunity to grow given the explosive growth in global e-commerce volume and increased usage of Internet-enabled mobile devices.
Market research firm Forrester expects U.S. online retail sales to grow rapidly and take market share away from physical stores. This is clearly evident from the comparison of Amazon’s growth with that of traditional brick-and-mortar retailers such as Wal-Mart (NYSE:WMT), Costco (NASDAQ:COST), Target (NYSE:TGT) and Best Buy (NYSE:BBY). Forrester further predicts that the U.S. online retail market will reach $262 billion in 2013, registering 13% growth over 2012.  Although the online channel still accounts for just 8% of total retail sales in the U.S., the future growth potential is huge and Groupon can not afford to miss this wave. Another market research firm eMarketer forecasts U.S. retail sales to grow at a CAGR of 14% over the next few years, increasing from an estimated $225 billion in 2012 to close to $434 billion in 2017.  While the U.S. growth outlook certainly looks promising, international markets can offer even higher potential in the long term
Groupon is heavily banking on the growth in mobile and Internet usage. The company saw over 7.5 million downloads for its mobile apps globally in Q2, with total cumulative downloads so far amounting to 50 million.  This is still a fraction of the company’s total subscriber base and there is significant opportunity to grow. The trend is encouraging as mobile platform’s share of North American transactions stood at 50% for June 2013, compared to 30% during the same period a year ago.  Given that Groupon is already placing large emphasis on mobile, its decision to expand its physical goods retailing business fits in perfectly, as consumers are moving towards mobile payments for their purchases.
Source: Groupon’s Q2 2013 Earnings Deck
The global smartphone market is growing rapidly, with Apple (NASDAQ:AAPL), Samsung and LG leading the way. The primary reason behind this growth is a large ecosystem of apps that Apple, Google (NASDAQ:GOOG) and Microsoft (NASDAQ:MSFT) have created. Worldwide smartphone sales touched 225 million in Q2 2013, registering a growth of 46.5% over the second quarter of last year.  The mobile devices are becoming the new focus of advertisers, marketers, retailers and payment service providers. Groupon can leverage this platform and sell physical goods via a dedicated app or through in-app purchases.
Our price estimate for Groupon stands at $6, implying a discount of about 40% to the market price.Notes:
- Groupon Eyes Warehouse Network For Goods, The Wall Street Journal Blog, Aug 27 2013 [↩] [↩]
- US Online Retail Forecast, 2012 To 2017, Forrester Research, March 13 2013 [↩]
- US Retail Ecommerce Outlook—What’s Driving Growth?, eMarketer, Apr 18 2013 [↩]
- Groupon’s Q2 2013 Earnings Transcript [↩] [↩]
- Gartner Says Smartphone Sales Grew 46.5 Percent in Second Quarter of 2013 and Exceeded Feature Phone Sales for First Time, Gartner Press Release, Aug 14 2013 [↩]