Is Groupon a Good Investment?

Groupon (NASDAQ: GRPN) is a $4.7 billion “deal-of-the-day” company that offers discount coupons to over 40 million users in more than 150 large-scale urban markets.  Originally believed to be the newest member of the ten-bagger tech community, to say that Groupon has disappointed post-IPO investors would be an understatement.  Since going public in November of last year, shares of GRPN have lost 71.7 percent of their original value, amid sliding profits and questionable accounting practices.

Now, many bears believe that the underlying issue behind Groupon’s problems is its business model, which has been criticized for being unsustainable in the long run.  Based on the prospect of providing one primary daily deal per market, such as “$10 for $20 worth of Chicago-style Pizza” in the Windy City, or “$12 for $24 worth of Cajun cuisine” in New Orleans, Groupon’s deals are extremely dependent on group participation.  If not enough of a preset quantity is purchased before the deadline, that particular deal is considered void, and all parties suffer.

Moreover, the company’s pay structure has been called unfair by many of its merchant partners.  Using the Chicago pizza example, a deal giving customers $20 worth of pizza for $10 only pays the restaurant $5, as Groupon typically splits revenues evenly.  According to the New York Post, it is estimated that around half of Groupon’s partners have expressed dissatisfaction with this pay structure, electing to not re-up their usage of the discounting service over the next 6 months.  In the future, it appears that Groupon may be placed between a rock and a hard place, serving as a marketing tool for struggling businesses that is cast aside once customers are made aware of their products.

In an effort to prevent this from occurring, the company has recently launched its “Groupon Works” platform, which aims at establishing a lasting relationship with merchants by giving them access to customer-specific data, and a team of growth specialists.  With its inspiration seeming to come from Facebook’s (NASDAQ: FB) Facebook Studio ad system, it is hoped that Works can serve as a “Development 101” system for new businesses.  Additionally, a new rewards program has also been announced, aimed at generating repeat business for partners, instead of the one-stop discounting that it had relied on in the past.  It is hoped by Groupon execs that both of these initiatives will give businesses a reason to stay after the honeymoon phase, so to speak.

While it is too early to tell if this strategy will have a material influence on the company’s bottom line, it is notable that Wall Street is forecasting robust earnings growth over the next two years.  After reporting a 98-cent loss per share in 2011, analysts are expecting Groupon to finish 2012 with flat earnings, while reaching $0.42 a share by the end of 2013.  If these estimates are to hold, it will have to be amid less-than-stellar competition from other daily-deal sites like LivingSocial, which is backed by Amazon (NASDAQ: AMZN), and Google’s (NASDAQ: GOOG) Google Offers platform.  While LivingSocial focuses on marketplaces in small to medium-sized cities, Google Offers takes aim directly at Groupon, operating in many of the same cities as its peer.  Created after the tech giant’s $6 billion offer for Groupon was spurned, Offers is essentially identical to Groupon save two major advantages: (1) coupons are valid no matter how many purchases there are, and (2) businesses are given the majority of their payment within one week of the deal.  Groupon, on the other hand, can take up to 60 days to remunerate its partners.  With some businesses blaming payment delay as a cause of insolvency, this time differential is clearly important.

Going forward, Groupon has the potential for appreciation, assuming that the Street’s earnings estimates hold.  If results are positive this year, it’s not inconceivable for GRPN to eclipse $12 a share by early 2013, as this would be a fair value based on the industry average Price-to-Earnings ratio (29.1X).  Though it is not possible to value GRPN as a function of its earnings, is notable that the company’s Price-to-Sales ratio (1.8X) is below tech peers like GOOG (5.1X), AMZN (2.0X), and FB (16.6X).

When growth is factored into the equation, GRPN does trade at a modest PEG ratio of 1.4; typically any figure between 1.0 and 2.0 signals a fair valuation.  This is above the PEGs of GOOG (0.9), and FB (1.2), but below that of AMZN (2.0).  From a cash standpoint, the stock trades at a Price-to-Cash Flow ratio (9.3X) below the industry average (16.7X), and the likes of GOOG (13.4X), AMZN (34.1X), and FB (40.8X), despite experiencing strong operating (233.3%) and free (226.8%) cash flow growth last year.

Amid these mixed signals and future uncertainty, WealthLift’s Sentiment Index rates GRPN as a sell, with over 80 percent of the community’s users placing an “underperform” rating on the stock.  It would be wise for investors to wait until the company’s second quarter earnings release on August 13th before making a play; any movement before then is purely speculative.  If results impress, the stock does have two-bagger potential from its current price in the $7 range.

Disclosure: The author has no holdings in the stocks mentioned in this article and has no plans to initiate any positions within the next 72 hours.  He does, however, have the intention of rating these stocks on, a social media website where investment ideas are shared openly and free.

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