Groupon's Acquisition of Ideeli Positions It to Take Over Another Industry

On Jan. 13, Groupon (GRPN 8.21%) announced the acquisition of Ideeli. The company acquired the online discount seller of fashion products in an attempt to improve its already-diversified business model. Because it is a step removed from what the company typically focuses on, investors would be right to scratch their heads and ask whether a transaction like this makes sense. Despite the disparity between the business model of Ideeli and its new parent, though, the deal might make more sense than you think.

A financial history of Groupon
From 2009 through 2012, Groupon has gone through quite a growth spurt. Over this timeframe, revenue of the coupon-selling website grew from $14.5 million to $2.33 billion. The growth in revenue can be attributed to a combination of growth in its North American segment and its International segment, both of which have seen sales rise more than 5 times since 2010 alone.

Currently, Groupon's fourth quarter results for 2013 aren't in, but judging from its performance in the first three quarters of last year there's not a lot to be excited about. In these quarters, consolidated revenue rose only 6.4% to $1.81 billion from the $1.7 billion the company reported during the same three quarters of the previous year. Following Groupon's 2012 fiscal year, management got rid of its International segment and replaced it with its EMEA (Europe, Middle East, and Africa) segment and Rest of World segment.

Unfortunately, the year hasn't been kind to either of these areas. In the first nine months of 2013, revenue in the Rest of World segment fell 14.7%. Although this is bad, it doesn't stack up to the 21.9% drop seen in the company's EMEA operations. Fortunately, this downside was more than offset by Groupon's North American segment. Over this timeframe, revenue rose 36.3% to $1.08 billion from the $790.3 million the company reported during the same three quarters the year before. 

According to the company's most recent quarterly report, the decline in revenue for its Rest of World segment can be chalked up to lower gross billings per average active customer.  During the nine month period, management saw gross billings fall 15%, mostly driven by a 20.3% decline in the company's Local category.  This, in turn, was due to a drop in the revenue Groupon saw per average active customer.  In its EMEA segment, management reported that gross billings actually declined, but the gross billings retained by the company fell as a percentage of total gross billings.

Despite the slight increase in revenue, the company was hit by a drop in profits. Whereas the company earned $13.7 million in profits in the first nine months of 2012, it had to report a net loss of $14.1 million in 2013. On a per-share basis, this meant that investors saw the company go from earning $0.02 during the three quarters to losing $0.02.

Groupon's strategic ambitions
Over the company's short history, management has focused on increasing revenue by attracting a larger customer base for its core business of selling coupons. In addition, it's also been dedicated to growth through diversification. Two very strong examples of this can be seen by looking back to 2011. During the year, the company began operating its Groupon Goods category where it sells products directly to consumers, just as Amazon has.

An even more interesting example of the company's dedication to growth can be seen in its 2011 partnership with Expedia (EXPE 0.33%) to offer Groupon Getaways. This category focuses on providing travel packages to consumers who are looking for a deal at a discount. The operation is still small so far, providing only 5% of Groupon's consolidated sales in 2012, but it has shown some strong results.

In 2012, Groupon Getaways reported a gross profit margin of 84.3%. To put the significance of this in perspective, you need only to look at the results that Expedia and Priceline.com (BKNG -0.43%) reported for the year. With a gross profit margin of 83%, Pricline.com (the largest player in the online travel industry) comes close to matching Groupon, but no cigar. Expedia's performance was even worse. The company reported a gross profit margin of 77.8% in 2012, meaningfully lower than Groupon Getaways.

Another way to look at this is by measuring each company's revenue as a percentage of gross billings. For the year, Groupon reported a margin of 23.6%. What this means is that for every dollar the company sold in travel services, it earned revenue of $0.236. Just as in the case of the company's gross profit margin, its margin for gross billings surpasses those of its peers. Priceline.com, for instance, saw its margin come in at 17.7%. Expedia was even lower, with its margin coming in at 11.9%--nearly half of what Groupon reported.

Foolish takeaway
Despite having a period of strong growth, Groupon has faced some challenges in both expanding and maintaining its profitability. To rectify the situation, management has taken a sensible approach to improving the business. By focusing on expansion through developing new ideas, partnering up with reputable industry participants, and making acquisitions, the company is trying to reach a little in each direction.

While this multifaceted approach to growth could hinder the company's profitability, it could also solidify it as a market leader in multiple industries. It was likely with this thought in mind that Groupon's management team decided to acquire Ideeli. Aside from being in an area in which the company has little concentrated experience, the business model utilized by Ideeli is similar to Groupon's. This allows management to leverage its resources to improve Ideeli's operations, while simultaneously giving it that diversity it seeks.