Thursday November 2, 2014 was a big day for Groupon (NASDAQ:GRPN), the online provider of event-driven coupons for goods and services. Late last year, the company announced plans to acquire LivingSocial Korea, the parent company of TicketMonster and a subsidiary of LivingSocial, a company that Amazon (NASDAQ:AMZN) owns 31% of. Staying true to form, the company finalized its acquisition on Thursday in a deal that cost $260 million. Though small when placed next to its $7.9 billion market cap, the deal paints a rather clear picture of Groupon's long-term aspirations.
Groupon's growing pains
Over the past four years, Groupon has grown at a rapid clip. Between 2009 and 2012, revenue rose from $14.5 million to $2.3 billion as the company attracted a large customer and merchant base. If analysts are correct, the company's sales should grow by another 8.2% to $2.5 billion for its 2013 fiscal year, more than 173 times the sales figure it earned five years ago.
Management has become stuck trying to find ways to continue their excellent track record. This point is best illustrated in the company's 2012 annual report when management stated, "we believe that in some of our markets, including North America, investments in new customer acquisition are less productive and the continued growth of our revenue will require more focus on increasing or maintaining the rate at which our existing customers purchase Groupons and our ability to expand the number and variety of deals that we offer".
Management's belief that to grow by means of optimization instead of expanding its acquisition of customers had led it to engaging in a number of costly acquisitions. During 2012, Groupon acquired ten businesses for $54.9 million, and another six businesses in the first nine months of 2013 for $15.1 million. It was around this time that management realized the value of TicketMonster and took a bite.
Terms are rather generous
Last November, Groupon announced its intention to buy up the South Korean operation in exchange for $100 million in cash and $160 million in Groupon shares. As part of the deal, the company received all of LivingSocial Korea's operations with the exception of its Malaysian subsidiary. Afterwards, South Korea became Groupon's largest region outside of the United States.
For what it paid, Groupon received a fast-growing business in the world's fifteenth-largest economy. In 2012, revenue for the entity came in at $76.9 million but its net loss amounted to $95.4 million. During the first nine months of 2013, revenue for the operation grew to $81.1 million, 56.2% higher than the $51.9 million the company brought in a year earlier. Due to costs falling as a percentage of sales (particularly its selling, general and administrative expenses), the company's net loss narrowed from $78.1 million to $40.2 million.
What exactly does Groupon see in TicketMonster?
Based on the data provided about LivingSocial Korea, investors are right to ask what Groupon is thinking. Here they are, buying a company for 3.38 times 2012's sales that is losing tens of millions of dollars each year. If this were all there was to it, shareholders would be right in questioning management's sanity.
Besides the benefit of expanding in another market overseas, TicketMonster has the kind of business model that Groupon has been striving to achieve. Currently, around 50% of the company's sales are generated from mobile devices. Recognizing this as an attractive source of growth, Groupon has been trying to expand its mobile exposure, finally hitting the 50% mark in North America and 40% worldwide last September. While it would have been possible to grow organically in South Korea without acquiring TicketMonster, the company felt buying it up, gaining its customer base and immediately gaining that 50% mobile exposure is a better way to go.
On top of the mobile opportunities and market-leading position that Groupon snatched up as part of the purchase, there is another major reason behind the company's actions; its product mix. In an effort to grow its business, Groupon has begun to move toward the business model used by Amazon.
In addition to facilitating third-party purchases, both Groupon and Amazon sell their own goods. Today, with a market cap of $182 billion and 2012 sales of $61.1 billion, Amazon is the big fish in the pond of online sales. With the introduction of its Direct Revenue operations in the second half of 2011, Groupon has started moving in the direction of selling its own goods. By the end of 2012, the company's first full year of revenue under this category came to $454.7 million. This quarter, sales came in at $200.1 million, 38% higher than last years' results.
With the acquisition of TicketMonster, Groupon bought a business that derives approximately 65% of its revenue from the sale of goods. The upside to this business model is that it allows for larger revenue growth over time and permits the company to keep all of the profit instead of passing some down to its merchants. However, there is the downside of lower margins. In 2012, the cost of revenue for Groupon's Direct Revenue operations came out to 90.6% of sales in North America and 108.9% of sales Internationally. To put this in perspective, the company's cost of revenue was only 19% of sales in North America and 13.7% Internationally during the same timeframe.
Assessing TicketMonster's value solely by its lack of profitability, we arrive at the conclusion that Groupon may have overpaid given such a steep price. However, when we consider that its acquisition allows Groupon easy access into Asia, grants it a market-leading position in one of the world's largest economies and sets the stage for Groupon's transformation from a discount coupon website into a miniature version of Amazon, the issue of cost starts to fade away. Right now, we don't know whether or not the company made a mistake in its purchase, but we do know that management is showing no signs of slowing down in the pursuit of its goals. That can't necessarily be a bad thing and certainly makes Groupon worth keeping an eye on by Foolish investors.