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Could Groupon Be the Next Netflix?

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Groupon (NASDAQ: GRPN  ) has slowly but surely undergone a transition from daily deals to e-commerce. But as it tries to become an e-commerce giant like Amazon (NASDAQ: AMZN  ) , transitions often lead to a very volatile stock such as Netflix (NASDAQ: NFLX  ) over the last five years. And while Groupon has lost the vast majority of its IPO valuation, the big question is whether it can enjoy a Netflix-like recovery?

The Groupon transition
Groupon's stock fell from over $26 to under $3 shortly after its IPO, but has since recovered to $8. Still, its significantly discounted price is a result of a dwindling coupon-like daily deals business. Yet, in the last year it has recovered as Groupon rolled out an e-commerce segment with extreme growth.

Groupon continues to have its daily deals business weigh down its total revenue, as its third party and other sales fell 3% year-over-year to $401.7 million. Despite this loss, Groupon's $768.4 million in quarterly revenue represented growth of 20.4%, thus showing the performance of its e-commerce segment .

Outperforming its peers
With just $366.8 million in e-commerce sales during its fourth quarter, Groupon is far less relevant in this space than Amazon. In fact, Amazon reported $25.59 billion during its last quarter, showing that Groupon is hardly in the same conversation.

With that said, one thing we've noticed in this market is that accelerated growth often carries a valuation premium relative to its peers, and Groupon is quickly becoming the fastest growing e-commerce company.

Currently, Groupon is trading at two times sales, and is expected to grow 21% this year. Amazon's growth outlook is similar, but at 2.15 times sales it is slightly more expensive. Thus, some might suggest that Groupon is presenting the same amount of value as Amazon. Although with it being smaller and its total growth hampered by the year-over-year decline of its daily deals business, it's possible that investors will soon accept Groupon's new-look company and its competitive advantage.

Furthermore, if Groupon can maintain a 40% to 50% growth-rate in e-commerce, it's highly likely that the weight of its daily deals will be far less significant on the company's stock.

A niche e-commerce business equals longevity
Groupon finds itself in a favorable position because it's not directly competing with the likes of Amazon, eBay, or even Overstock. While Amazon sells anything and everything, Groupon is still offering its customers deals, but now its deals are offered for longer periods of time and vary from blenders, to massages, or even weekend getaways.

This coupon e-commerce strategy provides Groupon with a niche market, one where it has no competition, and this fact might mean that Groupon is in fact a good investment for the future, and that its 40% to 50% growth is sustainable.

Give the market time
Historically, an operational transition often yields excessive volatility, and there is perhaps no better example than Netflix.

In 2011 Netflix shares fell from $300 to $60; shares had risen 800% in the five years prior. Essentially, the growth of its streaming plus DVD rentals business, caused shares to soar prior to 2011, was threatened. As a result, the company's 11.7% operating margin was also in jeopardy as Netflix turned its focus toward streaming, and had to fight higher content costs.

But then, Netflix evolved; it created better content, grew subscribers, and over the following three years, investors have learned to accept a new-look Netflix. Hence, it no longer matters that operating margins have fallen to 5.2%, because after a brief period of change, growth has accelerated and the metrics driving Netflix higher have changed.

With that said, it's this process, and ultimately this change that has both taken shares of Groupon lower, and that could lead it higher as e-commerce continues to grow. Essentially, Groupon has become the new Netflix, which was evident in its last quarter.

Groupon fell nearly 20% after reporting earnings, but it wasn't revenue growth or guidance that hurt the stock, but rather the fact that margins are under pressure. Its lagging daily deals unit carries a gross margin of 86.9% while e-commerce is just 7.9%. As with Netflix in 2011, this may hurt the company temporarily as investors adjust, but like Netflix today, the metrics most important to shareholders will change as Groupon continues to grow.

Final thoughts
By the end of 2014, e-commerce should dominate the majority of Groupon's total business, and for investors, this is a good sign.

The company is already trying to innovate and create more ways to boost growth, such as its recently announced Mindstorm email platform, which markets categories of deals rather than just one per email. It's this innovation that shows progress, and in the end, it's this process that will ultimately reward patient investors.

As Warren Buffett famously said, "If a business does well, the stock eventually follows." This quote couldn't be truer, and with 50% growth in e-commerce, and in judging Groupon's potential market in this space, this is a company that's doing very well. Hence, it definitely has the opportunity to become the next Netflix.

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Brian Nichols

Brian Nichols is the author of "5 Simple Steps to Find the Next Top-Performing Stock: How to Identify Investments that Can Double Quickly for Personal Success (2014)" and "Taking Charge With Value Investing (McGraw-Hill, 2013)". Brian is a value investor, but emphasizes psychology in his analysis. Brian studied psychology in undergrad, and uses his experience to find illogical value in the market. Brian covers technology and consumer goods for Motley Fool. Brian also updates all of his new and current positions in his Motley Fool CAPs page. Follow Brian on Twitter and like his page on Facebook for investment conversations and recent stories.

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