Why So Low, Groupon?

By Brandy Betz - August 21, 2012 | Tickers: FB, GRPN, ZNGA | 0 Comments

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Groupon (NASDAQ: GRPN), Facebook (NASDAQ: FB), and Zynga ​(NASDAQ: ZNGA) have been setting, and resetting, new 52-week lows in recent weeks. That mutual plummet has led to the three companies being discussed as a “failing tech stocks” bundle, but one of these things is not like the other.

GigaOm’s Om Malik argues that Groupon isn’t a tech stock and shouldn’t be treated like one. He has a point. While Facebook attempts to monetize through advertisements bolstered by user data and Zynga tries to boost in-app virtual purchases, Groupon has actual merchandise (or credits for merchandise) that’s up for offer and is essentially a retail warehouse gone digital. That doesn’t mean Groupon’s doing well; it’s just failing in its own special way.

Since the second quarter earnings report last week, GRPN share prices have been held down and some early investors have started running for the hills. What waved the latest red flags?

In a word: billings.

The Billings Problem

Gross billings are a Groupon metric that measures the total amount customers spent and are a strong indicator as to how the coupons side of the business is holding up. The second quarter saw the first quarter-on-quarter drop in billings and that drop happened even as the customer base grew. Gross billings dropped over 4% between the first and second quarters while active customers increased nearly 3%. That disparity led to an accompanying drop in gross billings/average customers (TTM), down 8% between quarters.

The billings include both the coupons and the Goods segments of the business. The growth of Groupon Goods, daily deals on direct merchandise, means that the coupons segment is faring even worse on the billings/customer front than it initially appears.  

The billings losses are a pretty big deal. As Felix Richter notes, Groupon flat-out said in its S-1 that “…[o]ur operating cash flow and results of operations could be adversely impacted if our gross billings do not continue to grow.”

How Good are Goods?   

Groupon Goods changes how the company offers deals to customers. Revenues for the daily deals, or coupons, are done on a net basis and involve Groupon paying the deal merchant a previously agreed upon percentage of sales. Revenues for Goods transactions can be on a similar net basis, if Groupon is, per the 10-Q, “acting as the agent of the merchant responsible for fulfillment.” Goods revenues are more often handled on a gross basis, in situations where the company takes on the risks of handling the inventory directly while gaining the ability to modify the deal price.  

Groupon Goods have existed for nine months and Q2 was the first time its direct revenue (the gross revenues) has been worth mentioning. Direct revenues were $65.4 million or about 12% of the quarter’s total revenue of $568.3 million. That’s a sizable step up from Q1’s $19.2 million.

Taking on inventory risks also elevates costs of revenue. That metric jumped to $135 million in Q2 from $55 million in the prior year’s quarter. That cost equals out to nearly 24% of the quarter’s total revenues whereas the 2Q11 costs were only 14% of revenues.

Final Thoughts

I agree that Groupon isn’t a tech company but it did suffer from a similar pre-IPO optimism that ended up biting Facebook and Zynga. The core business model wasn’t strong enough to support the great expectations.

The Goods segment isn’t hearty enough to become the top-line segment at this point, meaning that Groupon needs to, at the very least, keep its coupons side afloat. That’s going to be problematic if coupon-providing small business owners keep lodging complaints against GRPN, pertaining to payment failures and threats of lawsuits from sales reps, further shrinking the pool of returning deal offerings.

If Groupon’s reputation is sunk with the businesses it depends upon to fuel its business, how can it garner favor among investors?

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