Can Groupon Be Salvaged?

After Groupon reported wider-than-anticipated losses, shares plummeted more than 21%. Now, with shares having hit a new 52-week low, should investors take a big stake, or would Amazon or eBay be more attractive prospects?

May 13, 2014 at 10:15AM

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Source: Groupon

On May 7, shares of Groupon (NASDAQ:GRPN) fell 21% after the company reported earnings that fell shy of analyst estimates. Despite revenue growth that surpassed Mr. Market's expectations, investors fear that the e-commerce giant may never achieve profitability, enticing them to run for the hills.

However, with the company's stock trading at a new 52-week low and its goods category sporting strong growth, is now the best possible time for the Foolish investor to get into the fray? Or would other e-commerce sites like eBay (NASDAQ:EBAY) or Amazon.com (NASDAQ:AMZN) make more sense?

Groupon just can't seem to break even!
For the quarter, Groupon reported revenue of $757.6 million. In addition to being a whopping 26% higher than the $601.4 million the business reported during the first quarter of 2013, its performance was a nice clip above the $740 million analysts forecast. According to the company's earnings release, the main driver behind this increase in sales was its goods category, which saw revenue climb 68% from $229.4 million to $386.2 million.

This growth, which the company saw in all segments but especially in its rest of world (aka its miscellaneous international operations) segment, was partially offset by a 3% decline in travel revenue. Because of the significant improvement in its goods category, Groupon now attributes 51% of its sales to the operations, effectively displacing its local category as being the business' largest revenue generator.

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Source: Groupon

Although management handed investors a positive surprise on the top line, it was unable to do the same on the bottom line. In terms of profits, Groupon severely disappointed with a loss per share of $0.06. This is double the $0.03 loss Mr. Market wanted to see, and it is worse than the $0.01 loss the business reported in the same quarter a year earlier.

Despite seeing higher sales, Groupon's bottom line suffered as the cost of goods sold associated with its direct sales grew from 25.3% of revenue to 40.9%. The most likely explanation for this surrounds the company's source of revenue.

Because it's seeing sales rise in its goods category, which has a gross profit margin of just 16% compared to the local category's 87% margin, its weighted average gross margin can be expected to fall. This means that Groupon's management team will continue to have a hard time generating a profit for as long as this sales trend persists unless the business is able to extract additional economies of scale as it grows.

In spite of these troubles, is Groupon a strong prospect?
Over the past five years, Groupon has been a strong growth prospect for investors. Between 2009 and 2013, the business saw its revenue soar 17,650% from $14.5 million to $2.6 billion. While the company's early growth has come from its local category, management has switched its focus to selling goods online just as competitors like Amazon and eBay do. In just the past year alone, this part of the company has grown a jaw-dropping 47% from $773 million to $1.1 billion.

GRPN Revenue (Annual) Chart

Groupon revenue (annual) data by YCharts

Both Amazon and eBay have seen their top-line growth come in at a much slower, but still strong, pace than Groupon. Between 2009 and 2013, Amazon's revenue rose 204% from $24.5 billion to $74.5 billion, while eBay grew sales by 84% from $8.7 billion to $16 billion. All three companies have benefited from the advent of e-commerce, which is expected to reach $1.5 trillion in sales in 2014, up 20% from the $1.2 trillion reported last year.

Using revenue growth as the sole proxy, it would be crazy to say that Groupon is anything but a fantastic prospect. However, the fact that management has been unable to generate a profit during any of these past five years at a time when sales have ballooned is a cause for concern.

Amazon has also experienced some downside in profits, with net income falling 70% from $902 million to $274 million. Unlike Groupon, though, Amazon's rising costs can be chalked up to voluntary research and development expenditures that have risen 429% from $1.2 billion to $6.6 billion.

GRPN Net Income (Annual) Chart

Groupon net income (annual) data by YCharts

During this same time frame, the best performer from a profitability perspective has been eBay. Between 2009 and 2013, the e-commerce giant saw its net income jump 20% from $2.4 billion to $2.9 billion. As sales grew, so too did the company's dedication to research and development. However, the fact that management allowed these expenses to rise only 120% resulted in net income coming in at far more attractive levels than it did for Amazon.

If Amazon's higher research and development expenditures will eventually create even more significant competitive advantages over its peers than it already has, this will allow the company and its shareholders to see some amazing returns down the road.  On the other hand, the company's decision to allocate so much of its resources to these expenditures could leave shareholders with lackluster returns if the business is investing its capital sub-optimally.  

Foolish takeaway
Based on the numbers provided, it's understandable why investors seem to have lost some trust in Groupon. Yes, the company did enjoy higher revenue. But the fact that it still cannot at least break even on an earnings basis suggests that there is some underlying disconnect between what management is able and willing to do and what shareholders want to see. 

For this very reason, the situation at Groupon appears mixed, which might incentivize the Foolish investor to consider Amazon or eBay instead. There's no doubt that eBay is doing well. Amazon's numbers are mixed, but the company could easily reduce its research and development expenses and turn a higher profit.

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The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

Daniel Jones has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and eBay. The Motley Fool owns shares of Amazon.com and eBay. 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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