Groupon: Is there a case?

I am going to go out of my customary comment on Malaysian companies this time. There is one company which makes me think hard - Groupon. Why? Groupon is one company which probably their followers who accede to e-commerce transactions would know well. And it has been hit rather hard recently.

On the business side of things, the owners / management have created a fantastic (?) business concept. Why do I put a question mark? On one hand, it has built a great brand for itself. I see and hear people using it. It is the largest company in daily online deals market, by far. (If I am not mistaken, the second largest is Living Social which is one third owned by Amazon.) It has great business model. It has great reach, size, executed well enough to be the largest very quick. This kind of growth can only happen in US and from a US company (I think), as no one can put in such large amount of money into a business and let them burn more than $1 billion. And no stock exchange besides Nasdaq can a company raised funds at a valuation of more than $12 billion when it is yet to make money when listed.

On the other hand, Groupon has lost a lot of money in getting there. Fundamentalist like me would never agree as it is not value investing. Just look at the 3 years income statement below. Over the period, it has lost more than $800 million. But yet today, after the all time low, it is still valued at $5.45 billion. Well, at least this valuation is below the $6 billion price tag which Google offered them few years ago where the owners of Groupon rejected.

But is Groupon really that bad? What got me excited is that it is currently trading at all time low as mentioned above. To me the business can be great. It has superb growth. Another amazing thing is that, unlike Amazon, Groupon has been able to and has gone out reaching to the world (via acquisitions mainly) very quick with the help of the investment money it has raised. Today, it is in 47 countries - Malaysia and Singapore included. The company has grown so big so fast that it now has 11,000 employees worldwide.

What do I think of Groupon (until now)?

I was a pessimist. But now, after looking further, it may have a case, and when a company such as Groupon has a case, for a global business who is head and shoulders above its competitors, it can be worth much more than the $5.45 billion it is worth now. Why? Its business is so easily scalable. Investors always fear low barrier of entry, but for Groupon, it is low barrier of entry into multiple countries. No local company can compete when comes to speed and size of reach.

The largest problem for Groupon though, is managing the administrative costs, getting its merchants to continue to believe in the model and trust the discount system will allow the merchants to continue to sell. I believe that the challenge merchants will face when they start to provide discount via Groupon is that people expect discounts even when there is no discount.

However, if you look at things, merchants will have discount policies anyway during certain period especially during low seasons etc. Groupon just give them the reach and connects customers (looking for discounts) and merchants better.

Groupon has no problem getting subscribers and users to sign up. If there are good deals, people will buy.

Where do I find the company interesting then?

Collect cash upfront

One of my favorites. Groupon collects payment upfront and will only pay to the merchants after certain period (on average 60 days in US) and upon usage of their purchases for consumers in other countries. Hence, during the period when Groupon was lacking of funds, it was basically using these owings to the merchants to finance their operations, besides the fund raising.

No inventories

It is a business where there are little inventories. Low in other assets as well, such as properties, receivables in fact and can be high in cash assets for the company.

Mobile strategies

Unlike Facebook which finds it hard to find a revenue model through the mobile platform, people do use Groupon via their phones and tablets. There are in fact more and more people purchasing via their mobile devices based on percentage of purchases made via mobile platform to total purchases. Hence, moving forward with the increases of usage of smart phones and tablets in taking over more and more eyeballs from PCs, Groupon will not be affected.

Reduce marketing costs?

If it is able to reduce the proportion of its advertising costs to its revenue, it will continue to do well. Previously, one of the main reasons for Groupon to make losses was due to its aggressive marketing strategies. Now, as it reduces its advertising expenditure, what remains to be seen is whether it will continue to grow fast.

What about competition?

If there is a case in this business, it will even in fact be so dominant. One of the online traits is that most people will go for one platform which does the similar type of business rather than multiple sites. Hence, Groupon will be much bigger than Living Social or any other merchant discount sites despite they may be supported by much biggers companies such as Amazon, Google, Microsoft etc., if any. Groupon can survive by itself. My reasoning is - look at Amazon (winner) vs Barnes and Noble, Facebook (winner) vs Google+, Google (winner) vs Microsoft's search engines.

Moving forward

I feel that the last few years, when many were optimistic as well as many others were pessimistic (including me), Groupon despite the growth was finding its way. For a company which was growing so fast, it was bound to make a lot of mistakes but one of the most successful thing which the management of Groupon was able to do is to grow faster than anyone else. It was probably helped by the offer by Google which makes them instantly noticeable. In its last quarter results, it has already broken even and has a decent positive free cash flow of $73 million.

What it needs to do now? It has to be able to keep its administrative and marketing costs in check, while allow the revenue (gross and net) to continue to have positive momentum. With that, despite the high valuations based on current numbers, it's $5.45 billion valuation may not be that expensive as we thought it would be.

Let's continue to monitor this company. It is not value buy though - at least now.

What is Groupon?
Groupon is a local commerce marketplace that connects merchants to consumers by offering goods and services at a discount. Traditionally, local merchants have tried to reach consumers and generate sales through a variety of methods, including the yellow pages, direct mail, newspaper, radio, television and online advertisements, promotions and the occasional guy dancing on a street corner in a gorilla suit. By bringing the brick and mortar world of local commerce onto the Internet, Groupon is creating a new way for local  merchant partners to attract customers and sell goods and services.