Over 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:
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'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:
- 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.
- 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.
- 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?