Why These 2 Companies Are Much Better Deals Than Groupon

Adrian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Groupon (NASDAQ: GRPN) is the type of stock many would consider a trading vehicle, rather than a long term investment--and a look at the one year performance of Groupon will make you understand why. The amazing volatility this stock has seen so far is something that few investors would like to experience. Although the overall 52-week performance is positive (9.5%), we should keep in mind that the stock was almost 70% down in mid-November.

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That being said, since former CEO Andrew Mason left the company on Feb. 28, 2013 (one day after the company missed analysts' expectations for sales), the stock has clearly been experiencing upward momentum, which motivated me to study this stock not only from a trading perspective, but while taking a one year investment horizon.

Groupon: The Good

To begin with, nobody can deny the ability Groupon has to bring clients en masse to businesses. Furthermore, Groupon users seem to be more and more engaged. The time an average user spends on the site has been increasing steadily. And, even better, Groupon has dramatically increased its mobile exposure. According to the latest earnings call, 45% of revenue now comes from mobile (compared with a 20% in 2011), and in the latest quarter alone Groupon's mobile app was downloaded about 7 million times.

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Graphic based on Alexa metrics

Also, Groupon is constantly making improvements to its site in order to keep engagement metrics high. Just recently, the company made it possible for users to access ongoing deals instead of just one-time deals (Deal Bank Inventory), and the company is now working on building a single operating platform (One Playbook) which will bring a customer personalization algorithm and several tools (like return-on-investment tool) to merchants. Considering that Groupon is all about finding interesting deals, we can be sure that Groupon users will remain well engaged in the next quarters--but how about merchants? 

The Bad

The bad thing about Groupon is that the more attractive the product looks to users, the less attractive it may look to merchants. That's because there may be a huge trade off between the welfare of Groupon's users and its retailers. This was brilliantly proved in a working paper by Harvard Business School Professor Benjamin G. Edelman entitled "To Groupon or Not to Groupon." Groupon affects its retailers in two ways. First, it has the ability of sending users to merchants en masse, which is both a curse and a blessing. As Prof. Edelman mentioned in an interview last year, "The day after a Groupon is released, hundreds of buyers tend to swamp a small business unprepared for the rush. That barrage of customers can disrupt service to full-price customers, who may end up waiting for service." Second, discounts always create price asymmetries, and this may not be good for full-price loyal customers, who will obviously get upset when they realize others are getting large discounts.

Add to this the fact that it is relatively easy for someone to make a Groupon-similar website (perhaps a localized version) for a particular city. It does not take any advanced programming skill to create a system that posts and promotes coupons; and with some basic marketing and data mining skills, it is possible to spam your users everyday, offering them similar coupons. Add some gamification and seed-money for the SEO and you have your mini-Groupon running! There are low barriers to entry, and if Groupon wants to keep succeeding in this business, it needs to take care of its most precious asset: its merchants database. If competitors continue increasing in number, Groupon may find it harder and harder to attract merchants.

There are better deals

So far we know that despite growing its user base steadily, Groupon's business model has strong flaws that make it hard to attract merchants. Plus, Groupon's stock is certainly not cheap, at least not at $8.50 per share and with a forward P/E ratio as high as 54.9, according to Morningstar. This involves a $5.64 billion market capitalization, way too high for a company that is not profitable. Groupon lost nearly $4 million last quarter, has a negative EPS and may soon get a cut of the revenues from companies, in order to keep merchants interested and attracting more coupon sales. There may be better alternatives.

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Amazon (NASDAQ: AMZN) is well aware of the merits that local deals can have, and is providing some through AmazonLocal. But that's not all--the company has also invested in daily deals company LivingSocial, which posted sales of $135 million in the last quarter (up 23% a year ago), but also swung to a net loss of $50 million, from net income of $156 million in Q1 2012. That being said, there is an interesting risk/reward asymmetry here. Amazon has 29% equity stake in the company, so if LivingSocial ever turns profitable and massively successful, Amazon could have amazing returns on its investment. But if things go south, Amazon won't be in any danger because the company portfolio is well diversified. 

Chinese Renren (NYSE: RENN) also has some interesting exposure to the daily deals segment. Noumi.com, Renren's group buying business, is an early star, as sales have increased over 100% year-over-year and user metrics continue to be solid. They reached 3.1 million active paying users and a repeat ratio of 54%. Impressive, to say the least. With a $1.1 billion market cap, Renren could be a better deal than Groupon, as Renren has several products to diversify risk, from wedding sites to one of the most widely-used social networks in China. 

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Adrian Campos has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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