It's been two months since a pair of Wall Street analysts blasted Groupon (NASDAQ:GRPN) stock with negative notes, the most serious of which called the stock a "deteriorating" business, and the most optimistic saying only that Groupon stock is "a work in progress."
So far, those analysts have been proven mostly right, and Groupon stock has basically flatlined since its Q1 results in April. But could it be that Groupon is due for a revival?
One analyst thinks so. This morning, banker Piper Jaffray announced that it's upgrading Groupon to overweight. According to the analyst, Groupon stock that sells for just $3 and change today could hit $6 within a year.
Here are three things you need to know about the rating.
1. Costs are rising
As related on StreetInsider.com today, Piper sees Groupon "deploying marketing dollars to drive growth in North America local deals." On the one hand, that's a bad thing, as it implies that the company's costs will rise, perhaps pinching profits. But according to Piper, Wall Street is so far only "modeling for Groupon's marketing ramp" -- the cost side of the equation. What analysts may be missing, though, is the potential "for the gross profit generation from newly acquired customers."
2. Exploiting the market
According to TheFly.com's recap of Piper's note, Groupon plans to spend about $150 million to $200 million more on advertising this year than last. That certainly gives some cause for Wall Street's worry. But Piper says that Groupon is being more careful about how it spends its marketing dollars these days, "narrowing its product and regional focus to the categories where it can be successful." This is all being done in the interest of selling "the local deal," where (Piper says) the company "excels."
If successful in exploiting this market, Piper believes that Groupon will "consistently drive higher rates of capital productivity, leading to shareholder value creation." The analyst sees those $150 million to $200 million in ad dollars capturing somewhere from 3.5 million to 4.5 million new customers, and boosting gross profit by $215 million to $280 million -- as much as twice what the rest of Wall Street is forecasting.
3. Can that be right?
Focusing on the high figures, Piper is predicting that Groupon can acquire about one new customer per $44.44 spent, then reap about $62.22 per new customer in gross profit. If correct, then the marketing initiative should yield operating profits of about $17.78 per new customer -- a pretty nice 40% return on investment.
In total, the analyst is predicting as much as $80 million in new operating profit from the marketing initiative. And if that is correct, that would be enough money to erase Groupon's $55 million annual operating loss (based on trailing-12-month results from S&P Global Market Intelligence) and put Groupon back in the black. Indeed, even at the low end, $150 million spent on advertising, yielding $215 million in gross profit, would imply $65 million in extra operating earnings, which would again suffice to make Groupon profitable.
And assuming at least some of those new customers stick around, and don't have to be reacquired in future years, but continue spending on the website, then profits could grow even more in years to come.
The most important thing: Valuation
It's an optimistic story, and it might even be the right story. After all, while Groupon has not historically been a very good profits producer, GAAP losses have been shrinking over the past few years, and in 2015, Groupon actually broke into the black for the first time in five years, earning net profits of nearly $21 million.
That being said, at today's market cap of more than $2.2 billion, Groupon stock costs well over 100 times last year's earnings, and most analysts (Piper obviously excepted) forecast long-term earnings growth rates of no more than 17.5% annualized over the next five years. That's a pretty high valuation on Groupon stock, and I'm not sure that one positive prediction, from one analyst -- cutting across the current of many other analysts who have considerably less faith in Groupon's prospects -- justifies paying 100 times earnings for this stock.
Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he currently ranks No. 28a8 out of more than 75,000 rated members.
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