During a market sell-off, investors should always look for buying opportunities in solid companies. However, investors shouldn't confuse broken stocks, which are sold off in market panics with little regard to their underlying businesses, with broken companies, which deserve to fall due to fundamentally broken business models.
Two beaten-down companies fall into the latter category -- Groupon (NASDAQ:GRPN) and Angie's List (NASDAQ:ANGI). Today, I'll discuss why both companies' business models are broken, and why I'd never invest in either company.
Groupon: A market leader in a dying market
Back in 2011, Groupon made its public debut as the largest U.S. Internet IPO since Alphabet's Google. Since then, the stock has plummeted more than 80% below its IPO price of $20.
The problem is that Groupon's "daily deals" model, once hyped as the next disruptive force in e-commerce, wasn't designed to help participating companies. To attract customers on Groupon, businesses offered steep discounts on their products or services. Groupon then retained a 50% cut of each sale as a marketing fee, meaning that companies often took a loss on each sale.
That loss-leader strategy only works if customers buy additional products or become loyal customers, but many Groupon customers simply jumped to the next daily deal. In response, many companies started offering comparable discounts directly on their websites, which cut Groupon and its marketing fees out of the loop. Noticing that troubling trend, Facebook (NASDAQ: FB), Google, and Amazon (NASDAQ:AMZN) all shuttered their rival daily and local deal sites over the past few years.
Customers noticed that shift too, and Groupon's growth flatlined. Gross billings fell 5% annually last quarter, with a 5% gain in North America unable to offset double-digit declines in overseas markets. Global units sold (vouchers and products sold before cancellations and returns) slid 3%, and total revenue fell 2.4% to $732 million. Its GAAP net loss widened from $14.3 million a year ago to $49.1 million. To cut costs, Groupon laid off employees, shut down overseas operations, and started automating business applications to use fewer human employees. But all those moves will likely shrink its global presence and cause bookings to keep falling.
Angie's List: Who wants to pay for premium reviews?
Angie's List business model relies on people subscribing to its website to access a database of "trusted" reviews of businesses. That business model might have seemed sustainable during the late 1990s, when the database first went online, but Yelp (NYSE:YELP), Facebook, and Google now provide similar reviews for free. That's why Angie's List now trades at a 50% discount to its IPO price of $13.
Angie's List also sells advertising on the site to its listed providers, which critics claim contradicts its pledge to deliver unbiased business rankings and reviews. In 2013, the New York Times reported that Angie's List confronted users who posted negative reviews and tried to convince them to change their opinions.
Angie's List's revenue rose just 0.4% annually to $83.9 million last quarter. Its total paid memberships rose 7% to 3.3 million, but its first-year renewal rate was just 73%. On the bottom line, it posted a net loss of $4 million, compared to a profit of $4.4 million a year earlier. That widening loss was partially attributed to costs incurred from its "Profitable Growth Plan," which will include the removal of its paywall and the introduction of "freemium" and "premium" tiers this summer. The company also believes that it can defend its niche in reviews of home services against rivals like Yelp and Amazon.
If Angie's List growth plan works as advertised, its adjusted EBITDA might improve 10.7% to 25% this year, although sales are only expected to grow 0.2% to 3.2%. However, switching from a paywall model to a freemium one is the same strategy which aging newspaper publishers have repeatedly tried over the past decade, with very limited success. Since Angie's List lacks Facebook's social network, Amazon's e-commerce backbone, Google's search engine strength, and Yelp's brand association with business reviews, it will likely be crushed between these competing ecosystems.
Avoid these falling knives
Groupon and Angie's List both run on business models which weren't built to last. Groupon never made its daily deals model appealing enough for businesses, and Angie's List doesn't have a meaningful way to counter its bigger tech rivals.
At this point, I believe that only buyout offers can propel these stocks back toward their IPO levels. But considering that both companies rejected buyout offers before, investors shouldn't expect a takeover anytime soon. Instead, they should recognize both companies as broken companies which won't likely rebound without drastic changes.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Amazon.com. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon.com, and Facebook. The Motley Fool recommends Yelp. 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.