Zombie Apocalypse or Epic Buying Opportunity?

By Liz Hoffmann - July 20, 2012 | Tickers: AMZN, GIS, GRPN, KRFT, PG | 0 Comments

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We've all heard the hype about an impending Zombie Apocalypse.  You know, the day when some random nuclear event awakens, animates, and emboldens zombies everywhere. Hungry zombies will roam the countryside in throngs, seeking out that broken-down bus of hapless tourists.  The tourists will be stuck in the middle of the woods, it will be either dawn or twilight, and every single one of them will be immobilized with fear.  It is the scene that every zombie dreams about because it results in an easy, opportunistic, feeding frenzy.  And that is precisely why a Zombie Apocalypse can be eerily analogous to an Epic Buying Opportunity. 

Just as our traditional zombies approach what appears to be "easy feeding" in a fetid frenzy, eyes glazed and limbs twitching, our investor zombies do very much the same.  While they aren't fetid for sure, when zombie investors see a stock that may be vastly undervalued and/or the next big social media "thing", many get that same catatonic look.  They approach the stock in groups, lumbering ahead with eyes glazed, and look askance at the fundamentals.  They are buying into the hype and their hands quiver as they pour in their investment capital.

Now with those images as a backdrop, I'd like to take a good look at Groupon (NASDAQ: GRPN).  (I'll save my Facebook analysis for another day.)  My goal is to define what kind of opportunity (if any) we have, and since I'm writing this post  from an abandoned, boarded-up house, I'll do my best to focus and ignore the incessant screams coming from the outside.

Groupon has been getting some favorable press, based on the fact that the company has reached it's all time low in terms of stock price (epic buying opportunity) while simultaneously raking up it's highest sales numbers and revenues.  However, the fundamentals are still quite unsavory.  If we look at the numbers for the last 12 months, Groupon has a market cap of $4.95B, a P/E of -13.46 and EPS of -0.33.  Those numbers are driven by sales of $1.87 billion which netted a loss of $188.80 million in revenue.   Just recently the share price reached a new low of $7.02, down 77.5% from a high of $31.14.  Further, if we look a GRPN's gross margin of 81.93%, it might appear that it's a potentially lucrative business.   But digging deeper we see that the net margin is a negative 10%, and that spells trouble.  The trouble that I'm sniffing out is further validated by the fact that while sales for the past 12 months have increased dramatically at 414.60%, income has only grown 18.20%.  While it is double-digit income growth, we are still looking at hugely negative ROE of a -52.68%.  Could it be that they're giving the store away to drive sales growth? 

That begs the question can Groupon both increase their sales and margins to grow profitability? This is where we look at consumer and merchant dynamics to see if their business model makes sense.  Numbers can be used to paint bullish scenarios, but at the end of the day it's the consumers who make the final call.  How these consumers behave and feel is often overlooked as I discussed in my post "How Do You Put A Price On Love"

In general terms, Groupon needs to increase its subscriber base of consumers and at the same time, attract new merchants.  While this sounds pretty simple, it is anything but.  For many local businesses who have low-profit margins and/or low-traffic requirements, giving away their product at deep discounts via Groupon will be just too cost-prohibitive.  And the shoppers that they do get are "deal shoppers" who would never repeat the purchase at full-price.  Groupon's offerings are not typical consumer goods that people are going to purchase anyway.  Deals and discounts DO NOT create demand for non-essentials, especially during recessionary times.  The other thing to remember is that Groupon is not a unique offering and so even if a new merchant or consumer considers doing business this way, they have lots of other options.  Groupon has no discernible advantage over LivingSocial, which is partially owned by Amazon (NASDAQ: AMZN).  Groupon may have gotten to market first, but their market position is indefensible.  

With regard to consumer behavior, Groupon shoppers don't have habitual behavior and cannot be exploited in the same way that consumer packaged goods shoppers are.  Consumer packaged goods are always being bought (think toilet paper, coffee, bread, cereal) and bought repeatedly.  So manufacturers routinely subsidize these purchases with cents-off coupons and in-store promotions to drive sales and/or product trial (companies like Proctor & Gamble (NYSE: PG), Kraft (NASDAQ: KRFT), General Mills (NYSE: GIS), and Campbell Soup Co. have made a science out of such promotions.)  These programs work, are easy to implement, are inexpensive and cost-effective.  What does this have to do with our Groupon analysis?  Plenty, because while traditional consumer promotions are utilized and well-accepted by all involved parties (manufacturers, retailers and consumers), Groupon promotions are not.  

That's my analysis, even though I really dislike being a naysayer.  Especially given what I learned from the 2009 cult classic "Zombieland."  There's a scene in the movie where Bill Murray gives some great advice on deflecting zombies when he says: "Zombies don't mess with other Zombies."  So with that in mind, and the frightening realization that the room where I am writing this post is no longer secure, forget everything that I've just said.  For my own protection, I'm going to call my broker immediately and purchase some shares of Groupon.  Oh and by-the-way, was that a bus of tourists that just drove by?

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