Can Groupon achieve a $25 billion valuation?
The company once hoped for double its current market cap. Here's how it might just get there.
While Groupon has had its share of mistakes, including criticisms on its creative (and supposedly confusing) accounting metrics as well as PR mishaps, we try to explore a couple of scenarios that could propel the company closer to the original expected valuation of $25 billion. We recently launched coverage on our analysis of Groupon with a $8.6 billion valuation estimate.
Scenario 1: Groupons sold per subscriber are maintained
Groupons sold per subscriber is the average number of discounted deals (Groupons) bought by a subscriber for a given year. Given Groupon's monumental popularity during the 2008-2010 period, this number has remained historically high. According to our estimates, Groupons sold per subscriber stood at close to 2 and 0.9 in the North American and international markets, respectively.
Case studies from Groupon's own S-1 filings reveal that the company's business model has deteriorated in several of its mature markets.
In Boston, revenue per subscriber has declined from around $41 in June 2009 to around $13 by the end of Q3 2011. This trend sheds some light on the fact that many merchants might not find Groupon as profitable as the company claims, especially merchants who have high variable costs such as restaurants. This, coupled with the fact that Groupon's business model is highly replicable should lead to the Groupons sold per subscriber figure to decline in the future as we currently project.
Having said that, maintaining the Groupons sold per subscriber is achievable if Groupon wisely chooses its merchant base. Small businesses such as health services, spas and yoga sessions have a low variable cost element as they do not incur significant costs to add incremental customers. In fact, according to a survey by Rice University, 70% of such services actually made money after running a daily deal. Groupon can also benefit from improved payment terms to its merchants, many of whom find the 3-time installment of their money to be cumbersome.
Scenario 2: Groupon's take rate does not decline
Groupon's take rate refers to the percentage of revenue kept by the company on each Groupon it sells, with the remaining being redeemed to the requisite merchant. Based on the data provided in Groupon's S-1 filings, the company's overall take rate so far has declined slightly from around 43% in 2009 to about 41% during the first 9 months of 2011.
While Groupon's hefty discounts are certainly appealing to customers, the high take rates act as a double-whammy for merchants as they end up selling their products/services for close to 25% of the listed price. Given that the daily deals popularity has surged in the past 2 years, several merchants have jumped onto the bandwagon, enabling Groupon to charge a high take rate. However, as the market saturates, Groupon could face a double-edged sword. Merchants whose products/services have been popularized by Groupons in the past might not want to incur a 75% price cut. At the same time, merchants who fared badly despite running a Groupon would think twice before they run another deal. Due to this combined effect, we expect the take rate for Groupon to decline going forward.
This problem can however be mitigated through the same principles discussed in the first scenario.
High variable cost businesses such as food & drinks occupy over 20% of Groupon's total deals, and the merchants in this category can increasingly find it expensive to run Groupons. Given that most of the customers purchasing daily deals are simply hunting for bargains, the possibility of converting Groupon buyers into loyal customers is a long shot. Hence, Groupon should increasingly focus towards service oriented merchants, whose businesses can allow them to take a hefty 75% price cut.
If take rates for Groupon's featured deals divisions increase to 50% in the long-term, and Groupons sold per subscriber levels are maintained at historical levels, we expect the company's valuation to cross the $20 billion dollar mark. This would require a big strategic shift from Groupon's side, which has solely focused on aggressive expansion of customers and merchants in the past, many of whom have remained unprofitable.
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