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Here's How Groupon Needs to Prove Itself

By Chad Henage – Feb 6, 2014 at 2:30PM

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If investors thought that Groupon was out of the woods, there are three things the company must prove when it reports earnings in a couple of weeks.

With Groupon (GRPN 0.87%) shares nearly doubling in the last 12 months, some investors might believe the company is out of the woods. However, it seems like Groupon has to constantly explain and justify its business to doubtful investors and analysts. With earnings coming up in a couple of weeks, there are two ways Groupon might silence the doubters. However, one problem might threaten to derail all of the progress the company seems to have made.

The good and the bad news about goods
The problem with Groupon's original Deals business according to many analysts was anyone could offer what Groupon made available. For a while, the stock struggled under the idea that if a bigger company began offering similar deals, then Groupon could be squashed like a bug.

However, in the last few quarters, Groupon birthed a new business called Groupon Goods. The company offers goods at prices that no one else can match, and its millions of members love the idea. In Groupon's last quarter, the goods business represented 38% of total revenue,up from 26% in the prior year. With sales growth of 38%, Groupon was able to offset the nearly 7% decline in its Deals business.

Investors already know that (AMZN -1.63%) reported 20% sales growth over the holiday quarter. Behind the numbers, the company reported 23% growth in sales of electronics and general merchandise, which is direct competition to Groupon Goods. In addition, competitor eBay (EBAY -0.77%) reported that gross merchandise volume increased by 13%, indicating that the company had a good holiday season.

The first way Groupon needs to prove itself is by reporting significant growth in the goods business in its next earnings report. If Groupon Goods could grow sales by 38% in the quarter prior to the holidays, then the holiday quarter should be even better.

The bad news is, the company's goods business carries terrible margins. eBay's business model allows the company a huge gross margin of 68%. Amazon has improved its margins significantly over the last year, and now sports a gross margin of 27%. At the bottom of the proverbial gross margin barrel is Groupon's goods business at just 9.3%.

While Groupon's goods business growth might help the company's overall revenue, unfortunately it will come at the expense of the overall gross margin.

This number must improve
The second way Groupon needs to prove itself is by bringing its selling, general, and administrative expenses in-line with reality. In the last quarter, the company spent an unbelievable 49% of revenue on SG&A expenses. While this was an improvement from the nearly 51% expense rate last year, this is almost comically high compared to its two more well-known peers.

Amazon spends a ton of money on fulfillment and technology, yet the company spent about 25% of revenue on SG&A expenses in the current quarter. eBay actually spent more on a relative basis, with nearly 29% of revenue going toward SG&A. If Groupon wants to prove to investors that it can be profitable on an ongoing basis, the company's SG&A percentage must drop.

In the last nine months, Groupon would have reported earnings per share of $0.44 if the company had spent 30% on SG&A. Given that instead Groupon reported a negative $0.02 EPS during this same time frame, the importance of getting SG&A expenses under control can't be understated.

Not as good of a deal as you think?
The third way Groupon must prove itself is the company must be able to offer Goods at prices that can't be found elsewhere. In a worrisome change, it seems that both Amazon and eBay are at least finding a way to match or get very close to Groupon's pricing.

Recently Groupon offered a Samsung Blu-Ray player with Wi-Fi for $49.99. Though Amazon didn't match this price, the site did offer the same model for $54.99. Not surprisingly eBay has multiple sellers offering this same item at prices as low as $47. While this is just one example, Groupon has about 44 million active users versus millions more at both Amazon and eBay. Needless to say, any similarity in pricing to Groupon Goods is a problem that can't be ignored.

Final thoughts
If Groupon reports anything less than stellar results in its goods business, the stock could suffer. While Groupon's SG&A expenses may stay high, investors will want to see a light at the end of the tunnel.

In the end, Groupon must continue to impress investors and give a road map to consistent profitability. With a stock up nearly 100% in the last 12 months, anything less than great results could cause investors to take profits. If you want to see how Groupon does, add it to your personalized watchlist today.

Chad Henage has no position in any stocks mentioned. The Motley Fool recommends and eBay. The Motley Fool owns shares of and eBay. 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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