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Great IPO If You Ignore The Insider Sales

Shares of RetailMeNot (SALE), an online coupon site, have jumped more than 20% since the company listed on the NASDAQ on July 19. It’s a simple business model: provide a one-stop shop for deal-crazed consumers. Compared to other tech companies that recently went public—many of which have yet to turn a profit—its valuation isn’t that lofty. But deep-pocketed competitors are moving quickly in an effort to steal RetailMeNot’s market share.

RetailMeNot aggregates retailers’ digital coupons, from a 20%-off “friends and family” coupon for Kohl’s (KSS) to a free one-night DVD rental at Outerwall’s (OUTR) Redbox to half off a large pizza from Papa John’s (PZZA). When customers click on a coupon, they are given a code to print or redirected to the store’s website. Retailers—more than 50,000 of them, offering 500,000 coupons per month—pay commissions based on the sales that come through the site. RetailMeNot says those sales totaled $2.4 billion last year.

Its rapid growth in revenue, which increased 44% year-over-year in the second quarter, to $43.4 million, is helping to drive RetailMeNot’s stock price, as this stock chart shows:

SALE Chart

SALE data by YCharts

Customers adore coupons, which trigger the release of feel-good hormones in their brains, as YCharts has explained.

In short, it’s an attractive niche, and RetailMeNot has early-mover advantages. Its PE ratio, nearly 62 times earnings, is rich, but nowhere near Facebook (FB) or LinkedIn (LNKD).

Yet in its business model, RetailMeNot looks less like Facebook or LinkedIn and more like Groupon (GRPN), with its limited-time deep discounts on local businesses. As rivals have copied its strategy, Groupon remains unprofitable. Its shares have lost about half their value since the November 2011 IPO, as this chart shows:

GRPN Chart

GRPN data by YCharts

Like Groupon, RetailMeNot has opted to spend a lot of time buying up competitors around the world. RetailMeNot’s spending is far outpacing its revenue growth. Its sales and marketing expenses roughly doubled over the past year, mostly for marketing such as paid search ads to attract shoppers. It also is hiring more salespeople to recruit and retain retailers. The company said it expects this spending to eat up a larger share of revenues this year than last year. Its overhead expenses also nearly doubled, largely to expand its HR, legal and finance departments as a result of becoming a public company.

As a result, RetailMeNot’s operating margin has shrunk to 20.7% from 66.8% in the year-ago quarter, and its after-tax profit margin has fallen to 11.8% from 18.1%.

At its current share price, to settle at a typical PE ratio of 15 times earnings, RetailMeNot would have to quadruple its net income. If the company can’t get a handle on its expenses, that may be an unrealistic goal, especially because its growth will be challenged by well-financed competitors.

In its S-1 filing, RetailMeNot warned there are no significant barriers to entry, and much-larger competitors such as Google (GOOG), Yahoo (YHOO), Microsoft’s (MSFT) Bing and Facebook could use their sophisticated technology platforms to distribute digital coupons.

Indeed, the big guys are crowding onto RetailMeNot’s turf. Last month Google released new versions for Android smartphones and Apple’s (AAPL) iPhones of its Google Wallet, which includes online coupons. Facebook is adding more retailers to its reusable Facebook Card, which industry-watchers say could someday be used to store mobile coupons.

Another company, privately held Coupons.com, already replicates RetailMeNot’s business. While Coupons.com focuses more on CPG brands such as Kraft (KRFT), General Mills (GIS) and Clorox (CLX), it also has a section for retail coupon codes. In 2011, it raised $200 million from investors at a valuation of $1 billion.

This daunting competition may help to explain why RetailMeNot insiders cashed out so much stock immediately after the IPO. VC firm Austin Ventures sold 2.4 million shares, collecting more than $50 million, while Norwest Venture Partners sold 1.6 million shares for $33 million. (Each firm still holds about 5.8 million shares.) Many of RetailMeNot’s top executives liquidated their entire stake.

RetailMeNot understands perfectly how customers want to shop today. The problem is that its methods are so simple, inexpensive and easily replicated that tech giants are salivating over its business, and RetailMeNot may not be able to afford to keep up.

Amy Merrick, a contributing editor at YCharts, is a former staff reporter for the Wall Street Journal, where she spent 11 years writing about the Midwest economy, state and municipal finances, and the retail and banking industries. Her work has been published in the Poynter Institute’s Best Newspaper Writing series. She can be reached at editor@ycharts.com. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.

Read more articles about: Company Analysis  IPOs   retail stocks   tech stocks   

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