Daily deal juggernaut, Groupon (Nasdaq: GRPN), has been getting clobbered lately, which I predicted repeatedly.
Yet the selloff – from a post-IPO high above $31 to a recent low around $11 – has convinced some analysts that the stock is suddenly a compelling investment.
On Monday, Evercore analyst, Ken Sena, raised his rating on Groupon to “Overweight” from “Equal Weight.” He now considers it an “attractive entry point.”
Come again, Ken?
[ad#Google Adsense 336×280-IA]A falling stock price – even a dramatic 64.6% selloff like in Groupon’s case – doesn’t make a company suddenly attractive.
Not unless the underlying business is strong.
And when it comes to Groupon, its business hardly qualifies as such.
11 Reasons Groupon is a Goner
Groupon’s list of unattractive fundamentals is long. Really long.
So I’m going to just jump right in…
1. Less Than Reliable Accounting
Before Groupon went public in November 2011, the SEC clamped down on its use of misleading accounting metrics. Specifically, consolidated segment-operating income (CSOI).
Since that time, the company’s restated earnings. And revealed “a material weakness” in accounting controls, prompting another SEC investigation.
I might be willing to overlook one accounting “snafu.” But three? Not a chance.
2. Obscene Marketing Expenses
I’ve noted before that Groupon’s business requires it to spend on marketing to acquire new subscribers. But it’s getting ridiculous.
In 2011, Groupon spent $768.5 million on marketing, up 164% from 2010. That’s equivalent to 48% of total revenue.
In comparison, OpenTable (Nasdaq: OPEN), which also boasts a subscriber-based model, only spent 20.6% of revenue on marketing last year.
3. Uncomfortably High Overhead
As a result of ramping up its sales force from 128 people (March 2010) to 5,196 (December 2011), Groupon carries a hefty overhead burden. In fact, selling, general and administrative (SG&A) expenses were $821 million in 2011. That’s equal to 51% of revenue.
If you’re good with numbers, you probably noticed that marketing and SG&A expenses add up to almost 100% of revenue. Well, if we add in other costs – like processing fees, technology costs, acquisition fees, editorial costs, etc. – Groupon’s expenses top out at 115% of revenue. (That’s not a typo.)
4. Tons of Competition
When Groupon launched in 2008, it had zero competitors. Fast-forward to today and everybody wants a piece of the daily deals market.
Groupon now faces competition from literally hundreds of companies. That includes big players like LivingSocial, TravelZoo (Nasdaq: TZOO), OpenTable and Google (Nasdaq: GOOG). And other companies like The Wall Street Journal and Bank of America (NYSE: BAC), just looking to add incremental revenue.
5. Shrinking Margins
Since there’s no cost for bailing on one competitor and moving to another, merchants have a choice. They’re going to select the daily deals company that lets them keep the most amount of money. And to stay competitive, Groupon’s already being forced to give up more and more. Case in point: Groupon’s cut of gross billings is down to 40.4% from 42.7% in 2009.
6. Management Turnover
In a span of about two years, Groupon burned through three COOs. This is before the company went public, mind you. If Groupon’s future is so promising, you have to ask: Why did so many executives bail ship? My guess is they realized it was sinking.
7. Too Global, Too Fast
In the last year, Groupon’s revenue mix shifted. It went from earning 64% of revenue in North America and 36% internationally, to a mix of 39% in North America and 61% internationally.
Such a dramatic shift begs the question: Has Groupon already maxed out its potential in North America?
At the every least, expanding into so many international markets so fast is bound to create some operational nightmares. But don’t just take my word for it. As Groupon reveals in its 10-K filing:
“Expansion into international markets requires management attention and resources and requires us to localize our services to conform to a wide variety of local cultures, business practices, laws and policies. International acquisitions also expose us to a variety of execution risks. The different commercial and internet infrastructures in other countries may make it more difficult for us to replicate our traditional business model.”
8. Too Many Products, Too Fast
In three year’s time, Groupon’s dramatically expanded its product lineup, too. It went from just offering Daily Deals to offering Daily Deals, National Deals, Groupon Now, Groupon Goods, Getaways and Groupon Live. It even launched a $30 per year VIP program, which gives early access to deals.
Diversifying away from the core product so quickly is never a good sign. It smacks of trying to find new ways to squeeze more money out of the same customers. Which suggests the business is neither healthy, nor sustainable.
9. Dual Class Structure
Thanks to a dual class structure, Groupon’s founders retain about 57% of the company’s voting power. That’s an inordinate amount of control. And it makes it near impossible to bring about dramatic changes necessary to unlock shareholder value.
Groupon readily admits it, too. Its annual report, says, “This concentrated control will limit your ability to influence corporate matters and, as a result, we may take actions that our stockholders do not view as beneficial.”
10. Insider Exit Ahead
Groupon only sold about 6% of its outstanding shares to the public. That means most employees didn’t get a chance to cash out on the IPO. Yet.
But on June 1, when the lock-up period expires, they’ll be free to sell. And I have to imagine many of them will. After all, a bird in the hand is worth more than two in the bush.
11. Zero Profits
Given its heavy expense burden, Groupon has yet to report an operating profit. It may never, unless it can rein in expenses. And that’s not likely, in my opinion.
When you saturate a market, the marginal cost to reach a new subscriber increases, not decreases. Throw in added competition for those same subscribers, and costs go up even more.
Management doesn’t expect expenses to come down anytime soon, either. Per Groupon’s 10-K filing:
“We anticipate that our operating expenses will increase substantially in the foreseeable future as we continue to invest to increase our customer base, increase the number and variety of deals we offer each day, expand our marketing channels, expand our operations, hire additional employees and develop our technology platform.”
The Race to Zero for Groupon is On!
And while there’s more where that came from, you get the point. Groupon’s anything but a fundamentally strong business. A plummeting stock price doesn’t change that fact.
Bottom line: Stock prices ultimately follow earnings. And Groupon’s (Nasdaq: GRPN) chances of earning consistent profits are slim to none. So the race to zero for shares is on!
Any rallies along the way will prove to be dead-cat bounces. And at some point, management’s going to wish they sold out to Google when they had the chance.
Ahead of the tape,
Louis Basenese
[ad#jack p.s.]
Source: Wall Street Daily