Groupon’s Woes Can’t Be Solved by “Friendly” Hedge Funds

Groupon Accounting ProblemsOver the past month, shareholders of famed internet deals site Groupon (GRPN) have encountered a wild ride up and down more than 50% as top-performing hedge funds claimed a stake in the company. One of the best performing funds in the last two years, Tiger Global, disclosed it owned 9.9% of the company.

Someone close to the position later declared the investment to be “passive, not active,” suggesting that fund managers thought the company was a buy in its present form under its current plans, not as an investment in need of tough love from activist investors.

Let’s look at what Groupon might offer investors in its current form.

 

Groupon’s Current Financial Condition

All else being equal, Groupon is in much better shape today than one year ago. The company survives from daily deal sales to consumers, although much of the company’s gross profits are consumed by sales, general, and administration costs – the company’s employee headcount stands in the way of revenues flowing into earnings. I don’t need to tell you that Groupon has had a few rocky earnings releases given its horrendous performance since IPO.

However, I do want to make clear that Groupon is a vastly different company than it was fewer than 12-24 months ago. It’s changing.

By all measures that Groupon advertises to investors via its handy presentations, Groupon looks like a fine investment. The number of active customers (people who have purchased Groupons in the past 12 months) is on the rise, while the company is slashing marketing spend as a percentage of revenues:

Groupon Customers vs. Revenue

Of course, both of these statistics, though impressive by themselves, don’t really tell us all that much. First, the number of active customers is up, however the amount of money that each customer spent in the trailing 12 month period is on the decline. Groupon’s “TTM gross billings per user” fell from $188.55 last year compared to $148.78 today. This negative change nearly erases the positive change in active customers.  Just like Best Buy, this isn’t really a solid profit plan.

Most importantly, Groupon’s bookings from a year ago are not the same as Groupon’s bookings today.

 

Groupon’s Two Segments and Confusing Accounting

Groupon essentially operates two different segments: the normal well-known Groupon for local businesses, services, and goods as well as Groupon Goods, which sells physical products similar to sites like Woot.com.

The coupon business – selling discounted offers online – is a high gross margin business. The company recorded $423 million in third party revenues from this segment in the most recent quarter. The Goods business isn’t as attractive seeing as it sells physical products like any other retailer. It sold $144.9 million of Groupon Goods in the last quarter.

Groupon’s current “bookings per average user” (the stat on the decline) contains more physical goods sales and fewer coupon sales as a proportion of total bookings than a year ago. Coupon sales are much more favorable to the company than physical Good sales. So while bookings per user are falling, so is the gross margin of the product mix. Groupon is selling less stuff at a lower gross margin to slightly more people. That’s not a very good combination.

You wouldn’t know this was the case unless you follow along through endless loops of definitions and accounting clauses inside the company’s annual reports.

Additionally, Groupon seemingly ignores GAAP accounting, which it has been known to do before. The company carries inventory for Groupon Goods by every definition, but labels its inventory levels as “immaterial” and thus does not have any inventory on the balance sheet. In effect, there is no possible way to know how quickly Groupon turns over inventory, or the kind of returns it is getting on each capital turn. If Groupon is to sell investors on the idea that Groupon Goods is a favorable business for investors, it should be ready to document how much inventory it’s moving through the company.

 

Return to a Bright Spot: Groupon’s Assets

Groupon Client ListGroupon’s biggest asset is its unmatched mailing list. The company has 39.5 million active users about which it knows their current city, and with purchasing data it can understand customers’ ages, buying patterns, and preferences. This has real value.

The intangibles – an opt-in mailing list of people who signed up to buy stuff and data on its users’ buying history – are without a doubt the most valuable asset the company has. It’s the diamond in the rough.

Unfortunately, the true value of the client mailing list cannot be reasonably determined. Using a comparable sale – Woot was sold to Amazon for $40 per user – we can determine that Groupon’s list would be worth as much as $1.6 billion on the high-end. This comparable is from a company that had opportunity for growth – Groupon at 39.5 million active members is likely mature.

Additionally, Woot is similar to Groupon Goods, but not necessarily the business of coupon sales. Arguably, Groupon should be able to produce more value from its double-edged business than Woot could. So far, however, it has not.

 

What Groupon Needs to be Investable

All in all, I find Groupon to be, without a doubt, 100% uninvestable. Friendly hedge funds that support the current management will not necessarily hit hard on key issues facing the company today including:

  1. Solid Accounting Practices: Correcting very serious accounting issues, including the fact that it carries inventory but does not report how much. Investors need to know how quickly its inventory is being turned into cash and what the company is earning on each inventory turn.
  2. Cut Overhead: Making progress toward unlocking its valuable user data with a lower headcount. Salespeople are draining the coupon business. If Groupon can convince retailers, restaurants, and local businesses to submit their own deals via the website, Groupon would stand to keep more of the revenues it generates. Gift cards are the second biggest in the United States – the tiniest slice of this $100 billion+ business would give it substantial new cash flows.
  3. Settling on a Solid Profit Plan: Picking a model and sticking with it. While not the subject of the article as these businesses are in their infancy, Groupon is seeking to start a credit card processing business for local merchants. Additionally, it just opened a new physical retail center in Singapore to showcase its Groupon Goods business. (Please – if investors wanted physical stores, they’d go for Walmart!)

Hedge fund investors may be savvy. They may be capable of moving markets, but their ownership alone isn’t capable of turning the tides in a very questionable business model. There are simply too many questions and not enough answers. While I find the prospect of owning a portion of Groupon’s valuable mailing list attractive at the current price, management’s lack of focus, unnecessarily complicated accounting policies, and declining revenues in the core business make me think this one will have to hit a much lower rock bottom, perhaps even bankruptcy, before even thinking about a turnaround.

What are your thoughts on Groupon?  Is the coupon business sustainable? 

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Comments

  1. says

    I really do believe the coupon business is sustainable. There is simply too many people out there that love to save money, so if they’re able to reduce their overhead while keeping their current subscribers then they should be fine.

    • says

      I think it is in some form. They’ll probably have to give up margin and some sales to do it, but that email list has a lot of value in the right hands. If the recent rumors about a CEO switchup prove true, it could be an interesting play.

  2. says

    I don’t see a bright future for Groupon. It’s too easy for competitors to enter the market and that’s exactly what they’ve done. Banks are even jumping into the game by sending you deals related to your debit card spending.

    • says

      I think it was easy to compete with Groupon when people were fixated in the idea. Entrepreneurs and Groupon’s customers aren’t any more. As a $10 billion company, it was easy to create a Groupon-style company with a lower cost structure by acquiring customers at a lower acquisition cost than Groupon was worth per customer. However, I don’t think you could create another Groupon for less than what Groupon traded for a week ago.

      The way I look at it is that if you invest today, you’re essentially buying an asset (the mailing list) at roughly Groupon’s cost to create it. Previous investors wasted their capital paying too much for subscribers. Their capital subsidizes yours.

  3. says

    I don’t know if the business is sustainable. I agree that they need to fix the accounting and maybe look for other areas to branch out to separate themselves from competitors. I ashamedly bought Groupon. It was actually for my wife in a small brokerage account as she wanted to buy it. We took a very small stake in it as I was cautious and thankfully got out only losing $4/share as opposed to the $20+ some have.

    • says

      Good to hear you were able to cut your losses. At a $10 billion+ market cap, it was definitely priced for perfection and no competition.

  4. says

    My biggest concern for Groupon besides all of the obvious fundamental problems is the company does not offer anything necessarily unique to the table. Thus the barriers to entry are pretty low and competitors can, will and are beating them at their own game. There are several websites and companies that do not have the costs Groupon does, beating them at their own game. You can imagine, if you wanted to create a Groupon look-alike it wouldn’t be difficult to create a similar website with very little capital.

    JT, I’m glad you brought up the value of their mailing list because these are often forgotten assets in the internet community. One of the best ways to make money off a website or blog is to have a loyal following of which you have some information on. It is interesting though because Facebook has arguably some of the best personal information of users and many would argue is not monetizing it to a reasonable potential. The same might be said for Groupon.

    I would love to see something uniquely positive for Groupon, an asset, strategy or market that is completely untouched and untouchable before I would consider investing in them.

  5. says

    Didn’t know about the “Groupon Goods” store. Sounds like their accounting is jacked, and makes it tough to valuate them. I think their coupon business will continue to thrive, but it will be interesting to see if they are easy to knock off the throne, as online business are SO EASY to start up and customers seem to change directions very quicky if there’s a more attractive alternative.

  6. says

    Thoughtful article. I’m not sure about Groupon’s business model, but at least its balance sheet is in order. No debt, and plenty of cash on hand. That should give Groupon lots of flexibility as it tries to iron out its troubles.

  7. says

    It’s truly remarkable (and a little depressing) how far Groupon has fallen since their flirtations with Google. I still can’t believe that they walked away from billions of dollars in such a trendy niche with such low barriers to entry.

  8. says

    Here’s the part that made me laugh out loud: “By all measures that Groupon advertises to investors via its handy presentations, Groupon looks like a fine investment.”

    Isn’t it awesome how great companies look when you ask their media relations departments?

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