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Why Groupon Is Getting Clobbered After Beating Estimates

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Groupon (NASDAQ: GRPN  ) announced earnings of $0.04 per share, which beat expectations by $0.02 and sent the shorts running for cover. The stock rocketed up 18% until people actually read the press release and found that Groupon is projecting a loss rather than a profit for the coming quarter. This is surprising, since revenue guidance was $50 million more than expected. So, the company is closing more business but making less money.

The biggest concern with investing in Groupon is the potential to be driven into a competitive environment so intense that there is no profit to be gained from new ventures. The way to get around this issue is to find profitable niches and gain scale. This is causing the company to use the capital generated from its profitable U.S. business to invest in ventures that are unprofitable today, potentially wasting shareholders' equity.

If at first you don't succeed, acquire again
Part of Groupon's international strategy is to grow through acquisition. In the fourth quarter, this led to an $85.5 million impairment of an investment in Life Media Limited, a Chinese venture that has now been fully written off. This was a minority interest, which Groupon didn't fully have control over. But if the company is using acquisitions as a strategy for growth, should this be written off? Not every acquisition or joint venture will work out. Why shouldn't investors expect that some percentage of investments will be written off in the future? This quarter, Groupon is consolidating Ticket Monster and accelerating its marketing spending to support another acquisition, ideeli. Ticket Monster  is a Korean e-commerce company that is maintaining its brand and leadership. Ideeli  extends the company's brand into fashion and home decor in the United States. Combined, the companies cost Groupon $300 million in cash and stock, and both are unprofitable today.

Can the goods business hold up outside Christmas?
Of the $65 million in new revenue over the prior year, $53 million came from growth in direct goods sales. This is Amazon's (NASDAQ: AMZN  ) sweet spot, and if Groupon is perceived as a secondary vendor, this business may not retain its strength outside of the Christmas season. In a seasonally weak period -- or a more stringent competitive environment -- it is unclear if this business can grow or generate profits.

Increasing competition from Amazon
Amazon launched its local business in August of 2011, but it took a year to build momentum. In the first year, it expanded to 109 regions in 29 states, including the top 15 U.S. cities by population. The business is not significant enough for Amazon to address it directly on its earnings conference calls or break out revenue in the quarterly statements. But a rounding error to a company that generated $5.5 billion in operating cash last quarter can still be very significant. Cash equals options, and if a company decides to use this cash generated from another business to target Groupon's market, it can start a spending war Groupon has little hope of winning.

Summing it up
Groupon has significant challenges ahead of it, both internally and externally. If it doesn't execute flawlessly, it has little hope for survival. It needs to expand to find niches and build sustainable customer relationships to differentiate its brand from Amazon. But that comes at a cost to shareholders, whose capital the company is using.

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David Eller

I started contributing to the Motley Fool in 2013. I have held research positions at two investment banks and two hedge funds before trying more entrepreneurial ventures. I'm passionate about helping people find freedom in financial independence. Feel free to add comments and start a discussion. I hope to use these articles as forums to learn from you as well as share my opinion.

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Related Tickers

8/28/2015 4:00 PM
GRPN $4.60 Up +0.32 +7.48%
Groupon, Inc. CAPS Rating: *
AMZN $518.01 Down -0.36 -0.07% CAPS Rating: ***