Downside Risks Exposed In Groupon Inc.

  • Groupon fell short of investor expectations.
  • There’s no longer a compelling reason to buy the stock.
  • I have downgraded the stock and lowered my price target to reflect these risks.

So, before Groupon Inc.'s (NASDAQ:GRPN) quarterly earnings report, I was feeling fairly confident that some visible traction would materialize regarding sales/gross billings. But, it turns out that the broad consensus was more or less correct about the risks to execution and various downside scenarios. Groupon did beat with its headline figures, but buy-side expectations were a lot higher going into Q1’16.

I was also anticipating significant mobile app conversions or better billing metrics per active customer. Well, they failed on all fronts, and while they did better than consensus estimates, they delivered a deafening blow to a lot of buy side models as expectations were quite high going into the quarter. While it’s been a couple of weeks since Groupon reported, I wanted to make a quick update to my investment thesis with regards to Groupon and reassign a much lower valuation. At this point, it’s duly acknowledged that there could have been some flaws in the initial thesis.

There’s the potential that Groupon is already reaching market saturation given the high churn rates, which translates to lower lifetime value and heightened marketing cost just to maintain the current base of users. When looking closely at the investor presentation for Q1’16, North America active customers grew by 10%, however, the North America gross billings grew 5% y/y. Possible reasons include:

  1. The contribution from each new Groupon user is roughly half of the pre-existing base, which is far worse than what many were anticipating.
  2. To explain the divergence in billings and active customers, it could be owed to lower spending in the older customer cohorts due to attrition.

If active users are “still” more valuable on the front-end of the cycle, then it’s the declining spending of older customers that hampered the billings growth this quarter. Either way, the weakness in North America was the real surprise, and it’s what prompted many respectable managers to take flight the past couple of weeks.

Sometimes the bulls get it wrong.

5-15-15 GRPN pic 1

Source: Groupon

So, since we’re still in the early stages of a turnaround, it’s hard to pummel them completely for falling short of the whisper figures. Furthermore, I can acknowledge that my initial assessment of Groupon was completely wrong, so I have worked myself down to figures that are more realistic/beatable over the next couple quarters, and also assign a more realistic valuation as well. I know, I said that the last time, but given the unprecedented nature of volatility in the stock and total lack of certainty in the company’s financial trajectory, I believe investors are looking for any reason whether real or imaginary to get out of the name. However, given the risks of stagnating growth and a faltering growth strategy, perhaps investors have valid enough reasons to be so cautious.

5-15-16 GRPN pic 2Source: Alex Cho

I have adjusted my model to be more in-line with the management outlook. I have lowered my revenue estimate from $3.64 billion to $2.9 billion. Yes, I was substantially above consensus, but that was due to my estimate of active user turnover relative to mobile app penetration. I didn’t realize that the active customer growth would be so mediocre after nearly doubling advertising spend in North America. Ironically, Groupon is a marketing company that’s running out of ways to identify and retain new customers. There might be bigger flaws in the strategy, but for now, I’m transitioning to a far more conservative stance.

I have lowered my adjusted EBITDA figure from $535 million to $148 million for FY’16. This compares to management’s outlook range of $85 - $135 million, which implies that my estimate is more generous than what even management anticipates. Since we’re conforming to management’s estimates, and also anticipate a relatively slower growth rate (7.5% sales CAGR), I reduce my multi-year growth/value assumptions as well. As it currently stands, I value Groupon at $2.657 billion by 2020 and discount using a 14.1% discount rate translating to a 6-month price target of $2.33 from my prior price target of $5.91. Since Groupon is trading at $3.50, there’s the potential the stock drops even further, so I’m changing my contrarian buy recommendation to a sell rating. I believe there’s the slight possibility of an acquisition if it were to get cheaper than $2, so I really can’t encourage shorting the stock below that level.

You can also check out Amigobulls Groupon stock analysis video.

Alex Cho Alex Cho   on Amigobulls :
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