Bear of the Day: Groupon (GRPN) - Bear of the Day

I thought it was a good time to revisit the piece I wrote back then to recall why Wall Street analysts and investors were so underwhelmed and why the stock remains a #5 Rank. Here was how I approached a business I am not even sure I understood well enough to invest in...

"In the fluid world where e-commerce and social media waters merge, it's sometimes hard for investors to figure out what's going on with the business models and the growth strategy. That was no where more evident in February when Groupon crushed investor hopes again with another disastrous quarterly report." What follows is the bulk of the analysis from my February report...

The Q4 news wasn't all terrible as revenues jumped 20.4% year over year to $768.4 million, which beat the Zacks Consensus Estimate of $719.0 million. The year-over-year growth was primarily driven by a 63.0% jump in direct revenues, which offset a 2.8% decline in third party and other revenues in the last quarter.

And region-wise, revenues from North America and EMEA surged 18.2% and 42.5% year over year, respectively. This more than offset a 15.3% decline in revenues from Rest of the World (Asia-Pacific and Latin America).

But guidance was weak and signs of the turnaround got pushed further out as the decline in North American business is not what Wall Street wanted to hear. For this, shares were pummeled 22% to $8 on massive volume of nearly 140 million shares (more than 7X the average).

Clear Sailing in Platform and Mobile Growth

Groupon reported that active customers increased 9.0% year over year to 44.9 million, comprising 20.8 million in North America, 14.2 million in EMEA and 9.9 million in Rest of the World.

Approximately 50.0% of the worldwide transactions were through mobile devices. Moreover, more than 9.0 million people downloaded Groupon's mobile app during the quarter, which led to a robust mobile business.

Murky Waters in NA Comps and Biz Dev

Earnings outlook for Q1 and FY 2014 were significantly below consensus estimates with an implied FY EBITDA guide of $300mn vs. consensus of nearly $400mn. North America Local billings grew only 1.5% year-over-year over a tough comp a year ago when the company lowered take rates (rev share) to drive billings. But the deceleration from +13% y-o-y growth in Q3 remains a concern.

Gross margin plunged 660 basis points (bps) to 49.2% in the quarter due to unfavorable business mix. Adjusted earnings before interest, tax, depreciation and amortization (EBITDA) were $29.7 million compared with $71.9 million in the year-ago quarter.

Analysts at Stifel Nicolaus noted that "Groupon appears to be fixing its merchant-facing platform, but consumers have not yet responded in a compelling fashion. That is forcing some higher spending on marketing in 1Q/2014. Investments in two recent acquisitions (Ticket Monster and Ideeli, which both closed in January 2014) are also pressuring margins. Our billings estimate for 2014 falls slightly (ex acquisitions), while our EBITDA falls materially."

Groupon's net loss (including stock-based compensation but excluding acquisition-related expenses and impairment charges) was $1.7 million, which was slightly better than a loss of $25.8 million reported in the year-ago quarter. But a good chunk of this only came from lower expenses which is not really what Wall Street cares about right now with this company.

The Q1 guidance is probably what made investors shoot first last week. Adjusted EBITDA are expected to be between $20 million and $40 million, below the prior consensus estimate of $93 million, in part because of negative contributions from its recent acquisitions and additional marketing investments.

Dead Calm Before the Storm?

I met a former employee of Groupon last week (before their Feb earnings report) and asked him what he thought about the growth of their businesses going forward. I couldn't get an answer I was satisfied with as I watched the stock trade above $10. I knew a lot of major Wall Street houses were recently bullish with price targets near $15 so I was mildly interested in the opportunity.

But when I read the research reports following the company's quarterly blow-up, I wasn't any more sure what to make of this business -- except that earnings estimates, growth projections, and price targets were coming down.

Many analysts believe Groupon is well positioned to gain from the rising e-Commerce spending on mobile devices, a profitable domestic market and an under-penetrated international market. These opportunities can continue to drive top-line growth, especially with increased traction in mobile.

However, others believe that while the negative impact of increasing investments on profitability is a temporary factor, the company's decision to reduce focus on China is a long-term negative.

And Macquarie analysts talked about facets of the business that seemed important but which eluded my understanding...

"GRPN said the slowdown was due to a tough take-rate comp, delayed consumer purchases related to shift from a 'push' to a 'pull' model, and more email space dedicated to Goods."

Finally, the company continues to face significant competition not only from the stalwarts like eBay EBAY and Amazon AMZN but also from small companies like LiveDeal.

Bottom line: While the turn-around seemed promising, there are enough headwinds and uncertainties here to stay away. The Zacks Rank will tell you when it's safe to go back into Groupon. And the soonest we might get encouraging direction on that front is on May 6 when they report for Q1.

Kevin Cook is a Senior Stock Strategist for Zacks where he runs the Follow The Money portfolio.
 
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