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3 Reasons to Believe That Groupon Can Be Good

By Chad Henage – Feb 28, 2014 at 2:00PM

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Top line growth, lower costs and more where that came from.

I've heard some analysts suggest that Groupon (GRPN 3.19%) has virtually no "moat." In business terms, a moat is the differentiating factor that separates the company from its competition and provides protection against competitors. Originally Groupon lived on offering "Deals," which were essentially big discounts on locally offered goods and services. However, Groupon Goods is about to become the company's primary business. If this past quarter is any indication, this change in direction could be very good for Groupon investors.

If top line growth is what you want, the Goods business is very good
Growth investors sometimes are willing to forgo huge earnings and cash flow in favor of fast revenue growth. In fact, some have argued that price-to-sales is a more effective tool to compare fast growing companies.

Using this metric, a champion growth stock like (AMZN -0.77%) sells for a price-to-sales ratio of 2.2. By comparison, eBay's (EBAY -0.42%) price-to-sales ratio sits at more than 4. With Groupon selling for a ratio of 2.2, the company's price-to-sales ratio is equivalent to Amazon and actually cheaper than eBay.

When it comes to revenue growth, both Amazon and Groupon posted 20% revenue growth in their current quarters. While eBay only grew revenue by 13%, it's likely investors are willing to pay more for eBay's sales because of the company's huge margins and free cash flow.

This is the first reason Groupon could be good for investors, the company's revenue growth and price-to-sales numbers are on par with Amazon. Investors are willing to recognize Amazon as a champion growth stock, yet Groupon isn't normally afforded the same reputation.

A "good" path to better profits
While some would argue that a comparison between Amazon and Groupon is foolish (with a small f), the truth is, Groupon is a seller of goods and services. By comparison, 67% of Amazon's sales come from the sale of electronics and general merchandise. Since about half of eBay's business is from the Marketplace division, these three companies are more direct competitors than many would think.

The second reason Groupon could be good for investors is the company seems to be solving its selling, general, and administrative expense issues. Last year, Groupon spent nearly 50% of its revenue on SG&A expenses. In the current quarter, Groupon lowered its SG&A expense to just under 40%.

Compared to Groupon's SG&A expense, Amazon and eBay spend significantly less in this area. In their respective quarters, Amazon spent about 24% on SG&A, whereas eBay spent just under 34%. More traditional retailers like Wal-Mart spend as little as 20% on this same line item.

Groupon's SG&A percentage is connected to two issues. First, the company's fast expansion of the Goods business. Second, the high cost of dealing with local merchants and the sales process in the Deals business. However, as the Goods business begins to mature and gain economies of scale, these costs should decline. In a similar manner, as Groupon's Deals business becomes a smaller part of the whole, this divisions costs should mitigate as well.

Groupon seems to have begun cutting its SG&A expenses, and this change could help the bottom line tremendously. To put a number to this potential, a 30% SG&A expense line at Groupon would have added more than $130 million to operating earnings, or an increase of more than 900%.

Huge growth and more to come
The third reason Groupon could be good for investors is the Goods business is still in its infancy. Both Amazon and eBay offer millions of items, whereas the Goods business has just over 2,000 items today.

What is unique about Groupon's business is the company already gets 50% of its transactions from mobile. As more customers do their shopping through mobile devices, Groupon stands to benefit. The fact that only 8% of Groupon's customers searched the Goods section before making a purchase is a big opportunity for the company.

Groupon found that of the 8% that did a search, they spent 50% more than those that did not. With Groupon reporting just under 45 million active users, this means that more than 41 million did not search for goods on Groupon.

Considering that Amazon has millions of members, and the eBay Marketplace has 128 million registered users, Groupon could theoretically grow its active user base by 184% just to catch up to eBay alone. Given that Goods grew revenue by almost 63% in the last quarter, this business has the potential to change Groupon forever.

Good thoughts
Whether investors are looking for top-line growth, lower expenses, or huge potential, Groupon has it all. While the company's Deals business may be flagging in popularity, the company's Deals may bring users to the table, but Goods may be the key to keeping them coming back.

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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