Time to sell the coupon king

Groupon has risen quickly from obscurity -- and its downfall could be just as fast.

By MoneyShow.com Feb 8, 2012 1:01PM

Image: Hands catching shopping coupons (© Vstock LLC/Tetra images RF/Getty Images)By Paul Larson, Morningstar StockInvestor


 While Groupon (GRPN) has quickly made a name for itself, this recent IPO appears ripe for selling.  Even though the stock fell after the IPO, it still looks richly valued. Caveat emptor!


Heavy spending and rapid expansion has helped Groupon establish a market for "daily deals" and email promotions for local businesses. With a database of more than 115 million email subscribers, Groupon has built a large audience to market deep discounts (called "Groupons") offered by local merchants.

 
But in our view, the company does have an economic moat and this, coupled with an unproven business model, creates an inappropriate and elevated risk profile for public investors.


Groupon's business presents investors with three critical challenges:

  • The business does not scale well
  • Short-term advantages are neither durable nor profitable
  • The business model is unproven, leading to a wide range of potential outcomes for the company's overall valuation; we believe that investors face a nontrivial risk of permanent capital impairment
Moreover, while the company has benefited from a massive first-mover advantage, coupled with solid execution and a unique approach, the business is easily imitated. And we believe several competitors have a collection of assets with advantages over Groupon, ultimately making preservation of market share a difficult task.


The company is the largest provider of daily deals, and its growth in customers, merchants, subscribers, and revenue has been nothing short of stratospheric. (We project sales to increase more than five-fold to nearly $2 billion in 2011.)


However, the company has not been able to achieve profitability, as expense growth continues to outpace revenue gains. For our purposes, we are increasingly concerned about the firm's sales, general, and administrative (SG&A) expenses, which represent a disproportionate percentage of overall costs to the firm.


In 2011, for example, we estimate that SG&A expenses will still represent 50% of projected full-year revenue, despite the significant ramp-up in top-line growth.


While this reported expense may seem astronomical compared to other companies, we don't expect substantial improvement in this metric going forward. Each deal sold by a salesperson has to be negotiated, closed, and managed.


Additionally, Groupon manages an editorial staff (400-strong) that writes up creative descriptions of the offers to help drive consumer interest in the daily deals. Essentially, every deal requires a minimum number of allocated resources (people), whether it generates $10,000 or $3,000.


We believe that Groupon is primarily a local email marketing company that is hoping to transform itself into a local advertising powerhouse. This potential opportunity is not lost on the market, as companies including LivingSocial, Travelzoo (TZOO), Amazon.com (AMZN), OpenTable (OPEN), and Google (GOOG) have launched daily deal services as well.


Although Groupon has incredible brand recognition, it's not clear to us why merchants would avoid using the competition, particularly if they receive other services or better terms.


For example, Google has the ability to manage loyalty programs (through Google Wallet), bundle in other forms of Web advertising, and even offer better pricing for local merchants. Barring significant innovation by Groupon, we expect its lack of a durable competitive advantage to become more obvious over the course of the next two years.


The company has a very small window whereby it needs to build additional services to create customer loyalty and switching costs for the merchants. Consider us skeptical.


Subscribe to Morningstar StockInvestor here.


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7Comments
Feb 8, 2012 2:57PM
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GRPN is a fad, the deals aren't that great and once you step back and realize it's to get you to buy something you wouldn't normally buy you stop buying.

Feb 8, 2012 7:00PM
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I signed up with GROUPON and, within two days, an ever increasing number of unsolicited e-mails from an ever growing number of businesses, products, places, etc. began to completely overwhelm my e-mail account.  This daily waste of my time was unwelcome and uncalled for.  I cancelled my GROUPON subscription and am now, daily, working to get my number of unwanted

e-mail solicitations down. 

 

Whether their idea was a good one or not, this invasion of my privacy for their gain is unjustified and really pissed me off!!

Feb 8, 2012 7:05PM
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They should sell groupon bundles of their own stock.
Feb 9, 2012 2:04AM
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Perfect story in the wake of the housing bubble.  "A house that's worth $100,000 today will be worth $200,000 if you can just flip it five times" becomes "Buy a coupon for something you don't need, and you will have saved $10!"  Don't ya love a business that sucks in a lot of money and generates nothing of actual value?
Feb 9, 2012 12:25AM
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I've never signed up or use them, but they spam the hell out of me anyway.  Good riddance to bad rubbish.
Feb 8, 2012 8:18PM
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What is this Groupon for which you speak?
Feb 8, 2012 6:17PM
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I consider myself a smart consumer. Therefore the items I buy on groupon, or items i would have bought anyway. Specifically salon treatments. Therefore, I get astronomical discounts on what I would have normally paid to have these same services done had I not purchased the groupon.  A manicure normally costing me 20$ costs me 10$.  I know there's alot of people that will purchase things at a discount price that they would NOT have had they not seen the advertisement, so why not. That makes the business happy to get the business and if you ask me, this economy needs some spending! I love Groupon, I'm a big supporter and always will be.  I have tried some of the other copy cats too, but for some reason, groupon has me hooked solely now. It's precise, quick, convenient, easy to understand. IM HAPPY!  For me personally, it's not a fad. But thats just me.  And my deals are that great!
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