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After Posting Surprising Results, Where Does Groupon Go From Here?

By Jamal Carnette, CFA - Nov 8, 2017 at 5:33PM

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After shocking investors with a stronger-than-expected quarter, will Groupon continue to build upon its 60% year-to-date return?

Groupon's ( GRPN 4.50% ) stock is finally showing signs of life. On the back of a stronger-than-expected third-quarter earnings report and positive commentary regarding its forward outlook, shares jumped 7% in the post-announcement trading session. It's been a good year for the stock; shares of the deal site have rallied approximately 65% year to date, far outpacing the market's 15% return, as defined by the S&P 500.

Still, the positive quarter is of little solace to long-term investors. Currently, the stock trades hands for less than $6 per share, down more than 70% from the $20 IPO price in 2011. However, Groupon's history, including the third quarter, should be quickly forgotten. What matters is the company's future. Where does Groupon go from here?

A man, seen from the back and seated at a desk, raises his clenched hands in a victory gesture as he looks at a bank of computer monitors.

Image source: Getty Images.

Groupon's revenue decrease appears to be strategic

At first glance, Groupon's quarter appears to not justify a strong rally. Perhaps the most surprising metric is a decrease in revenue from $686.5 million in the third quarter of 2016 to $634.5 million in 2017, a drop of nearly 8%. Revenue for the first nine months ended Sept. 30 is down 6.5% from last year's corresponding period.

However, it appears this is by design. A mistake many companies make is to chase the next incremental dollar at any cost. The end result of this behavior is a decrease in margin and bottom-line figures, even while growing the top line. On the conference call, the management team, in no uncertain terms, noted that its focus was on gross profit, and the company has performed much better on that metric. In this quarter, the company grew consolidated gross profit 5.5%, even with the revenue decrease.

On the income statement, this strategy is clear. There is a shift away from direct sales to third-party sales. Nowhere is this trend more acutely noticeable than in the revenue in the North American goods segment, which fell by approximately 30% year on year. However, with a gross profit margin of 15%, it paled in comparison with the 84% and 77% margins of North American local and travel divisions, respectively. Groupon has a strategy; however, it must continue to execute.

International is the growth driver

While Groupon continues to derive the bulk of its revenue and gross profit from North American operations, its growth is coming from international operations. In the current quarter, the international segment grew total revenue and gross profit 8.4% and 10.8%, respectively, while North America registered a 14.3% revenue decrease and a gross profit increase of 3.1%.

This makes Groupon more susceptible to foreign-exchange (FX) headwinds in the short term, so look forward to hearing more about currency fluctuations and headwinds in future calls. This quarter, FX provided a tailwind to results -- without it, international revenue and gross profit would have increased only by 3.7% and 6.9%, respectively.

Looking beyond gross profit

With all the focus on gross profit, it's prudent to note that's not the be-all, end-all metric investors should embrace. In the long run, the company has to be a profitable, cash-generating enterprise, or it will be unable to sustain itself. On a positive note, the company this quarter produced positive free cash flow -- as defined by cash from continued operations minus purchases of property, equipment, and software -- to the tune of $9.6 million. The company typically generates the bulk of its cash in the last quarter, having reported negative cash flow in 2016's comparable nine-month period, so this is encouraging.

On the income statement, however, the company's EPS of $0.00 was aided by a few non-operational benefits. The first was a pre-tax gain of $17.1 million from the sale of intangible assets to Grubhub. Even with this benefit, Groupon reported a loss from operations of $1.2 million. This was offset with non-operations income to the tune of $7.5 million, mostly because of a gain from an investment sale and gains from currencies held by foreign subsidiaries.

Where does the company go from here?

After the earnings announcement, the company announced a host of changes to the board of directors, including a departure of Brad Keywell, one of the company's founders, leaving Eric Lefkofsky as the only one of the triumvirate that started the company. The company's stock performance in totality has been disappointing, to say the least, and it's in a tough business with very few barriers to entry. However, as the first mover, Groupon has an enviable brand and name cache in the space.

The new leadership appears laser-focused on gross profit and is transitioning the company to that end. It will be a bumpy road for sure, but it may be time to put Groupon back on your watchlist.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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