Is Groupon Inc Destined for Failure?

Groupon reported mixed results for its most recent quarter but Mr. Market was not impressed. Given this development, is the company a strong buy or is it doomed to fail?

Feb 24, 2014 at 5:30PM


Source: Wikimedia Commons. 

Investors buying into shares of Groupon (NASDAQ:GRPN) with the expectation that it would turn a profit during its fourth quarter are likely disappointed after the company reported lackluster results. Despite seeing an increase in revenue, shares of the online business plummeted 22%. Given the subsequent price decline, is now the time to jump into Groupon?

Groupon smashed on revenue but fell far short on earnings
For the quarter, Groupon reported revenue of $768.4 million. This represents a 20% gain compared to the $638 million that management reported the same quarter last year and outpaced the $718 million analysts forecasted. In its release, the company announced mixed results throughout all of its geographic regions.

In its North America segment, revenue climbed 18% from $375.4 million to $443.8 million. This jump was due, in part, to a nearly 10% increase in the region's gross billings. The company's EMEA segment, which consists of operations in Europe, the Middle East, and Africa, saw revenue climb a whopping 43% from $176.3 million to $251.2 million. Its rest of world segment saw revenue decline 15% from $86.7 million to $73.5 million.

In spite of the jump in sales, it couldn't deliver on earnings. For the quarter, management reported a loss per share of $0.12, falling short of the $0.02 profit anticipated by Mr. Market, and matching its results from the same quarter a year earlier.

The primary drivers behind the company's lackluster bottom line were rising costs and a significant impairment charge. Compared to the same quarter a year earlier, Groupon saw its cost of revenue rise from 44.3% of sales to 50.8%. The jump in costs stemmed from a 54.5% increase in the company's direct expenses, but was partially offset by a decline in its third-party expenses. This, on top of an $85.5 million impairment charge relating to the company's investment in Life Media Limited, made it impossible for it to turn a profit.

Is Groupon destined to be unprofitable forever?
Looking at multi-year results, we see that Groupon has never been a profitable enterprise. Between 2009 and 2013, the company's cumulative net loss amounted to $820 million on revenue of $4.3 billion. From 2010 through 2012, its bottom line loss started narrowing, and it looked like the business might finally be on its way to approaching break-even territory. Unfortunately, it hasn't yet worked out.

In contrast, other online businesses like eBay (NASDAQ:EBAY) and LinkedIn (NYSE:LNKD) have been able to report reasonable profits recently. Over the past five years, LinkedIn generated cumulative net income of $71.7 million on revenue of $3.4 billion. eBay performed even better. Between 2009 and 2013, the online auction site reported cumulative net income of $12.9 billion on revenue of $59.7 billion.

Both companies have grown revenue over the past few years, but LinkedIn has done so in a more aggressive manner. With the belief that its business model can create tremendous value, the social networking site has ramped up its selling, general and administrative expenses. Whereas these expenses amounted to 38.6% of sales in 2009, they have risen to 48.9% by the end of 2013.

From a profitability perspective, eBay has been far stronger than LinkedIn, but even it has its fair share of problems. Between 2009 and 2013, the company's net income rose 20% from $2.4 billion to $2.9 billion. This lackluster growth, in relation to revenue, came about because of an increase in the company's selling, general and administrative expenses, a modest rise in its research and development expenditures, and a one-time gain that artificially increased its bottom line early on.

In 2009, in an effort to strategically shift itself, the business sold Skype for $1.9 billion. This resulted in a $1.4 billion gain that inflated the company's bottom line for the year. Without this, eBay would have earned net income of around $1.2 billion, suggesting that its profitability jumped 136% over the past five years.

Foolish takeaway
Based on Groupon's financial results, investors should be concerned. Yes, the company did report a quarterly profit if you adjust for certain expenses, but that's like saying that if it weren't for gravity, the United States wouldn't have an obesity problem.

Going forward, it will be interesting to see how Groupon positions itself, but one thing is for certain; no company can remain unprofitable forever and survive.

Does Groupon fit the bill?
Based on the results of this quarter, Groupon's financial situation looks shaky at best.  However, short-term performance isn't always indicative of future success or failure.  In the case of Groupon, is it possible that it could be one of the best companies to help you retire rich or are there better options available?

It's no secret that investors tend to be impatient with the market, but the best investment strategy is to buy shares in solid businesses and keep them for the long term. In the special free report "3 Stocks That Will Help You Retire Rich," The Motley Fool shares investment ideas and strategies that could help you build wealth for years to come. Click here to grab your free copy today.

Daniel Jones has no position in any stocks mentioned. The Motley Fool recommends eBay and LinkedIn. The Motley Fool owns shares of eBay and LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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