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Did Groupon Deserve This Bounce?

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Groupon (Nasdaq: GRPN  ) smashed Wall Street's expectations in Monday night's first-quarter report. Share prices jumped as much as 27% on the news before settling down to a more modest gain during the day's trading.

The daily-deal slinger reported $0.02 of non-GAAP earnings per share on $559 million in sales, ahead of the $0.01 per share and $530 million predicted by the average analyst. The results were also an inspiring improvement over the $0.41 loss per share on $296 million in sales seen a year ago.

Where's the love?
So the company eclipsed the Street's targets, but analysts are hardly impressed by the show. Deutsche Bank noted that the strong bottom-line take followed from lower marketing expenses, which doesn't look like a sustainable tactic. The firm reaffirmed a "hold" rating on Groupon with price targets dropped from $21 to $15 per share. Goldman Sachs stuck to a "buy" rating on the stock but lowered its price targets from $25 to $22 per share. Citigroup raised Groupon to a "buy" status while also slashing the target price from $24 to $22.

And the beat goes on. Doing a quick survey this morning, I found four new or reiterated "buy" ratings, each one paired up with a lower price target.

That might sound peculiar, but it's really not that big of a mystery. These analysts have probably not updated their targets for a couple of weeks. Today's market bounce only brings Groupon back to prices last seen in mid-April; Setting a $20 price target six weeks ago would have left just 10% of headroom. "Hold" grades that seemed perfectly reasonable then would often yield a "buy" rating today.

In the meantime, Groupon has seen several accounting scandals while Facebook's upcoming IPO stole the last great new thing's thunder. It's not easy to prop up share prices of a rickety business under those circumstances.

What did you say?
Yeah, I think Groupon stands on feet of clay. The best tool available for juicing earnings is lower marketing costs, but then the company loses revenue growth in upcoming quarters. It's a devilish trade-off any way you slice it.

The whole model might work if Groupon could reach some kind of tipping point where the business just grows on autopilot -- Netflix (Nasdaq: NFLX  ) did this with its famed DVD mailing business and hopes to do it again in digital streaming, for example. (Nasdaq: AMZN  ) carved out its leading role in e-tailing by chasing customer growth early on, at any cost. These are simple growth models where word of mouth does at least half the magic.

But Groupon simply cannot do the same thing. Without an ever-growing army of hands-on salespeople pitching Groupon deals to coupon-printing partners, the whole business would stall. Sure, the emailed daily deals to consumers are easy enough to manage -- but what happens if (when?) you run out of willing coupon partners?

But wait -- there's more!
Maybe you're still on the fence regarding Groupon's bounce and potential gains. The Wall Street Journal helpfully points out another reason to stay far away: There's a massive wave of dilution coming down the turnpike. The lock-up period that restricted underwriters and insiders from trading Groupon shares will expire on June 1, releasing some 90% of all Groupon shares onto the market for the first time.

"Investors shouldn't step in front of a potential tsunami of selling," quoth the Journal. As a reminder, fellow online darling LinkedIn (Nasdaq: LNKD  ) saw shares falling 17% in a matter of days when its lock-up period expired. These are no empty threats, people.

My bearish CAPScall on Groupon is suffering today, but I'm still convinced that it's the right play in the long run. This company is an impressive top-line growth story today, but the bottom line simply can't follow suit and investors have seen right through the ruse. There are plenty of rule-breaking multibaggers out there, but Groupon ain't one of them.

Fool contributor Anders Bylund owns shares of and has created a bull call spread position on Netflix, but he holds no other position in any of the companies mentioned. Check out Anders' holdings and bio, or follow him on Twitter and Google+. The Motley Fool owns shares of Netflix, LinkedIn, Citigroup, and Motley Fool newsletter services have recommended buying shares of LinkedIn,, Goldman Sachs, and Netflix. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 16, 2012, at 7:32 AM, nikolotta wrote:

    What fools are contuining to buy this pig? Does anyone do their homework? Did anyone read the latest SEC filing?

    I'll translate Groupon's filing into plain English: "Unless a bunch of ignorant small business owners open up shop on Mars and the Moon, we will be bankrupt before we are ever profitable."

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