Online deals purveyor Groupon (NASDAQ:GRPN) is still reeling from the aftermath of a 20% collapse when it released disappointing first-quarter earnings. What seems most surprising is that Groupon didn't do all that poorly from a fundamentals perspective. The company missed profit expectations only by a few pennies per share and posted strong growth in both revenue and gross billings.
Groupon has done well to grow its sales and user base. But it's still reporting losses, quarter after quarter. That's having a huge effect on its shares, which have lost more than half their value over the past two years, and more than three-quarters of their value since the company's IPO.
Digging deeply into Groupon's financial reports reveals a disturbing trend over the past few years. Groupon booked $93 million in stock-based compensation charges in 2011. Stock compensation then jumped 11% in 2012, and another 17% to $121 million last year. Put simply, Groupon is using vast amounts of shareholder money to enrich its employees through lucrative stock-based compensation awards.
When buybacks are hazardous to your wealth
You might be tempted to immediately equate share buybacks with value creation. In many cases, that's certainly true. Companies that repurchase their own shares for cancellation can create value for existing shareholders. When those shares are retired, there are fewer shares outstanding. That means that there are fewer slices of the pie left over, and each remaining slice gets a bigger portion of the company's profits.
Usually, companies that reduce shares outstanding effectively will enhance their earnings per share. And, whereas dividends are taxed, share buybacks are a tax-advantaged method of returning cash to shareholders. Unfortunately, not all buyback programs are created equal. If they so choose, management teams can use buybacks to simply offset the dilution caused by massive option grants. When this happens, very little wealth is created. Groupon is a prime example of this.
Groupon's option grants are out of control
Over the past three years, Groupon has consistently reported fairly significant operating losses. Curiously, though, the company's revenue has gone up considerably. Groupon booked $1.6 billion in revenue in 2011. Last year, revenue increased to more than $2.5 billion. That represents 56% revenue growth in just three years. And yet, Groupon reported a net loss in 2011, 2012, and 2013.
You might instinctively attribute this to exploding operating expenses. Indeed, it's true that Groupon has invested aggressively to expand, including the acquisitions of Ticket Monster and Ideeli. However, rising costs still aren't what's causing the company's losses. In fact, Groupon's operating expenses, which include things like marketing costs, selling, general, and administrative expenses, and acquisition-related costs, actually went down by 10% from 2011 to 2013.
What really seems to be keeping Groupon from generating positive earnings per share is its practice of awarding exorbitant amounts of stock to its employees. For instance, Groupon spent $46 million repurchasing shares last year, but its shares outstanding actually increased during that time. Looking back further, the trend is even more striking. From 2011 to 2013, Groupon's shares outstanding soared by 83%, from 362 million to nearly 664 million.
Groupon is authorized to purchase an additional $224 million worth of shares over the next two years. But the company acknowledged that these repurchases won't do what they essentially should do. The company stated: "[T]he program ... is intended to partially offset dilution from employee stock grants."
Groupon should treat its shareholders better
Groupon reported a net loss last quarter and missed estimates by a few pennies per share. It seemed like a relatively slight miss, but it was enough for investors to send Groupon shares crashing 20% after the quarterly report was released. It's hard to say for certain, but it stands to reason that perhaps Groupon wouldn't have missed expectations if it conducted more shareholder-friendly practices.
Normally, allocating hundreds of millions of dollars to share buybacks is an effective, tax-advantaged way of returning cash to shareholders and boosting earnings per share. When used improperly, however, share buybacks do little to create value for investors. Unfortunately, when it comes to Groupon, the latter seems to be the case. Groupon is utilizing share buybacks simply to enrich executives and other employees. If the company cares about its shareholders, it needs to change this.
Bob Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. 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.