Talk of Rekindled Google-Groupon Romance: Our Bucket of Cold Water
The share price of Groupon (GRPN) surged 23% on Friday, closing at its highest level in weeks, on remarks by an Internet analyst that Google (GOOG) is circling the social commerce company. Deteriorating fundamentals in the online coupon distributor’s core business and a less-than transparent balance sheet, however, suggest a bid won't be forthcoming.
The 73% decline in market value since the November 2011 IPO could make the daily deal site “a takeout candidate,” said Telsey Advisor Group’s Tom Forte. Groupon had allegedly rebuffed a $6 billion offer from Google the year prior to its public debut.
No long-term debt, a cash hoard of $1.2 billion (left over from last November’s IPO), and an enterprise value of just $1.87 billion -- “Where the stock is currently trading, said Forte, “it’s a takeout candidate.” A market cap chart helps.
Contrary to Forte’s valuation argument – the Chicago-based Groupon remains a coupon-driven business, just one of many available to online shoppers. Further, a growing number of analytical and survey-based studies report disillusionment with the alleged effectiveness of coupon promotions. In particular, merchants are questioning the long-term profitability of daily coupon ventures, as a low percentage of customers spend beyond the deal value (with even fewer returning for full-price purchases). Evidence is surfacing, too, that shoppers drive up store congestion by waiting until expiry to use their coupons, which negatively affects perceptions of the participating vendors.
Groupon management says that it is addressing such concerns and is working more closely with its merchants to (a) improve profitability (such as, its new mobile payment app, called “Payments,” which will offer more competitive swipe-fees than the 2% - 4% transaction costs associated with traditional charge cards) and (b) design online promotional offerings that increase percentage of coupon redeemers into loyal customers.
Nonetheless, operating metrics demonstrate end-user demand inertia: active customer-base grew 36.7% for the trailing twelve-months ended September 30 – but, average revenue per customer fell 16.4% to $63.96. Additionally, reported nine-month profits of $26.2 million were principally due to a pre-tax gain of $56 million, from the sale of online E-commerce assets.
Other online coupon providers are feeling the hurt too. Amazon (AMZN) has seen its $175 million stake in LivingSocial disappear, as the online retailer reported $169 million in impairment charges related to its equity holdings in the privately-held, D.C.-based daily deal site in the last quarter. LivingSocial is also scaling back operations, having announced that it is letting go 400 employees, or 10% of its global workforce.
Irrespective of unattractive margins, given limited barriers to entry, the business model Groupon helped pioneer is attracting hundreds of one-stop shops, all employing a plethora of differentiating user models – like Atlanta-based Scoutmob (mobile phone app-deals) or Yipit and 8coupons (aggregators of flash, “deals of the day”) -- that connect local residents to steep discounts on a variety of goods and services, from health-club memberships and spas to restaurant or tickets to sporting and entertainment events.
Through September 2012, Groupon spent 68 cents of every $1.00 in sales on SG&A and marketing expenses, down from $1.05 last year. Direct competition to its core operations suggests word-of-mouth will not be enough to introduce relevant deal offerings, nor slow customer churn. Ergo, an increase in subscriber costs will likely pressure operating margins – and cash flows – in coming quarters.
Groupon said it threw off free cash flow of $145.3 million through September, according to regulatory filings. In my opinion, however, management is being less-than transparent with respect to liquidity:
• Specifically, $54 million was directly attributable to accrued liabilities (total payables owed to vendors for cash collected upfront climbed to $573.5 million);
• $68 million of this cash, too, was tied to delays in timing of payments owed for operating expenses (like payroll) and online marketing costs;
• The company could be understating its potential customer refund liabilities (third-party revenues have risen more than 30% this year, yet refund reserves have climbed only 3% to $69.8 million); and,
• No reserves have been set aside for breakage revenue -- escheatable groupons purchased as gift cards.
With $45 billion in the bank, Google is constantly prowling for acquisitions that would compel prospective merchants and consumers to engage premium services tethered to its own branded social network platform Google+. Acquiring Groupon, however, is unlikely to increase the visibility of its own proprietary daily deal site, Google Offers, nor bring the search king any closer to taking global traffic away from Facebook (FB).
David J. Phillips, a contributing editor at YCharts, is a former equity analyst. His journalism has appeared in Bloomberg BusinessWeek, Forbes, and Kiplinger's Personal Finance. From 2008 to 2011, David was a reporter for CBS News Interactive.