Groupon GRPN
April 10, 2019 - 5:46pm EST by
leob710
2019 2020
Price: 3.50 EPS $0.20 $0.24
Shares Out. (in M): 625 P/E 17.5x 14.6x
Market Cap (in $M): 2,200 P/FCF 9.3x 9.2x
Net Debt (in $M): -600 EBIT 162 217
TEV ($): 1,600 TEV/EBIT 11x 8.3x

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Description

Overview / Background:

Headquartered in Chicago, IL with over 6,500 employees, Groupon, Inc. (NASDAQ: GRPN; "Groupon" or "the company") is a global leaver in local commerce, whose vision is to increase consumer buying power while driving more business to merchants through price and discovery.  The company's main product, groupon.com -- which is localized in many countries and on mobile apps -- is an online marketplace that provides consumers discovery of local services, experiences, and goods at discounted prices.  Despite being perceived as a has-been e-commerce company, Groupon remains a top 5 E-commerce brand, top 10 U.S. App, and has over 70% of its transactions conducted on mobile.  Groupon baosts 48.2m active cusotmers around the world. 

The company was founded in 2008 by Andrew Mason, Eric Lefkofsky, and Bradley Keywell and IPO'ed at $28/sh in 2011. The company switched management teams in 2015, promoting Rich Williams to CEO and hiring CFO Mike Randolfi.  Williams had been COO since June 2015 and President of North America since 2014 after having joined the company in June 2011 as Senior Vice President of Marketing.  His prior experience includes a a variety of marketing leadership roles at Amazon and Experian.  

The value proposition for merchants is based on the benefit dervied from a platform where they can generate new business with no cash outlay and optimize their available inventory.  At the same time, the company provides customers with the ability to discover local businesses and events and receive potential discounts at those businesses and events. The company provides local merchants with a unique marketing and customer acquisition channel, as well as a convenient way to create a digital footprint and boost its online presence. Furthermore, with the adoption of G+, the company has the opportunity to provide merchants with customer attribution, LTV, and related analyses, which may help local merchants (many of which are unsophisticated) see the value of Groupon.  The copany continues to invest in several areas, with a focus on mobile, card-linked offers and third party supply. 

Williams and Randolfi have steered the company's strategy towards a focus on profitable growth, cutting back its international footprint from 47 countries down to 15.  Other goals in enhancing the company's profile while exhibiting financial discipline include maintaining a 12-18 month payback of incremental spend, maintaining a leverageable cost strcutre, targeting 2020 EBITDA of $300m+, and opportunistically repurchasing shares (as of February, the company had $290m remaining authorization)  Strategically, the company has tried to expand from its "daily deals" roots, partnering with a variety of companies to position itself as a local discovery platform.  

Groupon reports three product categories over two geographical segments: North America and International. Product categories are: (i) Local (72% of LTM GP) - Offerings from local merchants, as well as local events. Subcategories include restaurants, beauty and spa, health and fitness, as well as events and activities. This is the segment the company is currently most focused on. (ii) Travel (7%) - Travel offers, including hotels, airfare, and package deals. (iii) Goods (20%) - Sell merchandise inventory directly to customers, as well as allowing third parties to sell customers on the Groupon platform.

GRPN is by far the leading online local discovery platform, especially after 2016, when it bought LivingSocial, the then #2 player. Google and Amazon used to compete in the space but have since both exited, arguably indicating the difficulty and distraction of trying to build out such a platform. The company's biggest current competitor and future threat is Facebook, which has local deal offerings in its marketplace. Other indirect competitors include Yelp, Grubhub (also a partner), and other online shopping platforms - GRPN competes with them both as platforms for customer expenditure and as advertising channels for local merchants.

Thesis

Despite a Q4 2018 EBITDA miss that was largely driven by headwinds in North America and promotional activity in international and a 2019 EBITDA guidance that fell short of expectations, we believe the company’s equity is compelling at today's levels for many reasons, including the following:

Attractive valuation:  Moderately healthy company trading at levels reserved for extremely challenged companies: Groupon is trading at 7x 2018 EBITDA and 0.7x 2018 revenue, levels typically reserved for extremely challenged internet businesses. Although it's true that Groupon will likely never meet the growth expectations set upon it at the time of its IPO, it is not particularly distressed, displayingprofitability while increased gross profit 3% over the past two years. EBITDA is growing even faster, up 50% over the past two years. Furthermore, some investors are focused on revenue and bookings growth, which is obfuscated by GRPN shifting away from goods and introducing G+, which sacrifices upfront revenue for more recurring revenue - akin to a subscription transition by a SAAS company.  

Clear category leader with significant upside opportunity: GRPN is by far the category leader in the online local discovery & discounts space, especially after having acquired LivingSocial, then the #2 player. It has a well recognized brand name and limited direct competition. Should recent strategic changes be successful, the company has the opportunity to benefit from a massive local opportunity and accelerate its growth due to the classic 2-sided flywheel effect - more merchants / partners lead to a better product for customers, which lead to more customers, which lead to a better channel for merchants / partners. Due to the flywheel, many internet categories tend to be "winner take all" (online shopping - AMZN; online restaurant reviews - YELP; search - GOOGL; online auctions - EBAY, etc.), and Groupon is arguably the clear leader in local.

Benefits from secular tailwinds: The company has the potential to benefit from several secular tailwinds, including: 1) shift to mobile - GRPN has a top-rated app and ~70% of its transactions were completed on mobile devices; 2) shift from valuing goods to valuing experiences, especially among millennials; 3) shift to supporting local businesses, especially among millennials; 4) growth of e-commerce. 

Attractive upside/downside: We believe the upside/downside analysis is very favorable. Given the current valuation and flywheel characteristics mentioned above, the upside for the company is high, especially in a "blue sky" scenario - there is a history of successful internet platforms compounding substantially in value. The downside here is limited, given lack of financial leverage (albeit high operating leverage), and the margin of safety characteristics outlined below.

Downside protection: We believe there is a margin of safety in this investment, including: 1) near-ubiquitous brand name, along with 50mm active customers - that should be worth something to strategics; 2) presence of strategic investors/partners, including BABA, Atairos/Comcast, and IAC; 3) a growing repository of customer and merchant data, especially with the G+ rollout; 4) very low financial leverage and negative net leverage, which reduces chances that equity investors receive no residual value; 5) some counter-cyclical business characteristics, as consumers are more likely to look for discounts during recessions.

Results misunderstood by market and obfuscated by transformation: Based on numerous sellside reports, we believe that the market is in a "wait and see" mode in assessing Groupon. Thus far, although gross profits and EBITDA have increased (largely due to cost-cutting), the company has not shown metrics that indicate signs of a turnaround. In North America, the number of customers have declined in 2018, reversing a trend of growth in 2017. Although the company explains this as having a more focused marketing campaign targeting more profitable customers, overall GP / active customer has not grown. Notably however,  the transition to G+ and sale of OrderUp is probably obfuscating some of these overall numbers.  Specifically, G+ moves customers from paying a high amount upfront to paying a lower amount over time, which may reduce the timing and amount of transactions in the near term in exchange for more recurrence of transactions in the future. If GP per customer is stable through the transition,  this implies the underlying comparable GP / customer is actually growing.

Takeout candidate: Recode reports that the company approached several public companies in attempt to get acquired this summer. The presence of BABA, Comcast, and IAC as investors has also sparked takeover speculation. However, there has constantly been speculation of GRPN being acquired, and thus far there hasn't been an acquisition, so it's fair to wonder if all the logical acquirers have passed on the opportunity already.  Of course, as the stock continues to languish or decline, the attractiveness increases.  Moreover, Groupon recently settled  a patent litigation lawsuit brought by IBM, removing what arguably may have been an overhang or hindrance to a potential deal last year. 

Key risks, and potential mitigants, are the following:

Unattractive/unworkable business model: The daily deals category is unattractive and not a sustainable business model. There is deal fatigue from customers and it is an ineffective customer acquisition / marketing tool for merchants. The merchants only gain "deal hunters", who are not customers willing to pay full price. The fact that Amazon exited its daily deals site Amazon Local, and that LivingSocial was sold for nothing, proves that the business model is untenable and the daily deals market is shrinking. We believe this is the biggest risk and the key issue we have to get comfortable with. Potential mitigants: Groupon has shown it can operate profitably in the space; it is now a local discovery platform rather than just a daily deals platform; G+ and the many partnerships GRPN has entered into enhance the value proposition for the customer; value proposition for merchants is intact as incremental customers bring immense benefits to local businesses with high fixed costs (rent) and many local businesses have little alternative ways of getting the same reach that Groupon offers.

New business strategy has not yielded many results: As mentioned above, investors have stayed on the sideline as the company has not shown any gains in customer numbers or GP per customer, especially in North America. Beyond anecdotes, it is unclear whether G+ and the new partnership model is actually beneficial. Potential mitigants: Same as above - we believe the transition takes time and depresses near term GP, akin to a subscription transition. The benefits of G+ are reduced friction and less embarrassment for a customer, and ease of use and faster and simpler transactions for a merchant, which makes sense from a theoretical perspective. 

High cost structure leads to risk of operating de-leverage: GRPN's SG&A was $1.1bn in 2015, representing 85% of GP at the time. The company has successfully cut $200mm from its SG&A, but LTM SG&A (adjusted for the IBM lawsuit) was still 65% of GP. The large fixed cost base means that any declines in GP will have an outsized effect on EBITDA and cash flow - if the topline shrinks, the company won't be able to support its cost structure. Potential mitigants: Further opportunity to cut SG&A (per management), this also results in operational leverage in the upside, and we like the upside/downside as detailed above due to other forms of downside protection.

Significant execution risk: GRPN has switched management, and new management has embarked on a new strategy. This inherently involves a lot of execution risk, and GRPN is still in the middle of the transition - there is no guarantee it will be successful. Potential mitigants: The company has already shown improved and growing profitability, the management team has a strong background in management (as opposed to just being in management because they founded a company), finance, and operations.

Valuation & Estimates

Groupon is cheap, trading at 7x 2018 EBITDA and 0.7x 2018 sales. This compares to comparable online merchants / shopping platforms trading at 35x 2018 EBITDA and 6x 2018 revenue. The only comparable online platforms trading at GRPN's levels are QRTEA (fka QVC) at 8x 2018 EBITDA and 1.1x 2018 revenue, and potentially CRTO, a digital performance marketing company, trading at 4x 2018 EBITDA and 1.2x 2018 revenue. According to MS, challenged internet assets trade at 6-8x EBITDA. Groupon IPO'ed at $28/sh and is now trading at $3. We believe one of the primary reasons Groupon has traded off is because it failed to live up to its initial promise (due to both operational missteps and the daily deals market not being as attractive as thought) and is no longer seen as a growth company, which was confirmed when it switched management teams and began focusing on profitability and growing profitable dollars. Furthermore, there is perception that GRPN is a daily deals platform that has lost its luster, and has therefore been disregarded by the market.

Our base case estimates assume that the company is able to moderate its NA customer decline as it works through the churning of unprofitable customers, and as new initiatives take effect, while the international customer base continues to grow. We believe that gross profits per customer will increase, especially internationally, as the company executes its transition to card-linking. Our target price is ~$6.15, based off of an 8x 2021E EBITDA of just under $400mm, which represents a 21% IRR from today’s price.

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Traction in new strategy

Takeout

Clearing low expectations/guidance

 

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