Should You Take This Deal

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

Every investment in the stock market has an inherent risk, but some investments are obviously riskier than others. In any industry, every stock has a different risk profile, but some industries are similarly riskier than others. Internet companies are one of the riskiest investments on the block. This is because, unlike others corporations, there are no tangible assets to fall back on, i.e. little liquidation value. The entire value of the company is based on future sales estimates and the value of the website, i.e. the brand. For such online businesses, it is very difficult to calculate the true revenue base and thus a probable value of future cash flows. These valuation/estimation issues lead to varying assumptions about the true value of the investment and are the primary reason why investors have lost and earned so much from investing in Internet companies.

In the last few years, the investors of Groupon (NASDAQ: GRPN), Pandora (NYSE: P) and AOL (NYSE: AOL) have seen shifting fortunes. As the chart below shows, the stock prices of Groupon and Pandora have declined significantly. The stock price of Groupon has declined by approximately 77% in the last couple of years. This decline has been due to the company’s inability to convert sales growth into profit growth. It has even been called a Ponzi scheme by investors, and serious concerns still remain on the ability of its business model to create shareholder wealth. AOL is a very different story; since the company has gone public it has taken a smart and focused approach to generating profits. Unlike Pandora and Groupon, AOL’s stock price has skyrocketed with a return of 82% in the last two years.

 

Source: Google Finance

Groupon

The company posted its earnings for the quarter ended December yesterday. The street was expecting Groupon to post an EPS of $0.03 per share on revenues of $639.8 million. The company missed expectations and reported an EPS of $-0.01 on revenues of $638.3 million. Another major concern for investors was the adverse forecast for the current quarter. The combination of this bad news has driven down the company price by 22% and has raised more questions on the business model of Groupon.

The primary reasons behind this ‘miss’ and the lower expectations for the current quarter are the renewed marketing efforts by Groupon. The company is trying to raise merchant interest in its deals program. In the fourth quarter, the company started sharing more revenues with merchants to increase their interest in Groupon deals. According to CFO Jason Child, Groupon plans to continue its efforts to increase growth and merchant profitability. The company has forecasted that it is expecting revenues in the range of $560 to $610 million for the first quarter. This is way below street expectations of $650 million in revenues for 1Q2013.

Bottom Line

The quarterly results have raised more questions on the long term ability of Groupon to create shareholder wealth. It has not only missed expectations but also given weak guidance for the current quarter. Groupon is trying to reduce its take rate in order to increase merchant interest in its deals program. There was already a lot of criticism on the low margins of Groupon, and this cut will only increase these worries. These earnings have raised more questions and reduced investor confidence in the business model of Groupon. I recommend investors to stay away from Groupon due to falling margins and bad outlook for the current quarter. 


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