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May 18, 2012

Some further thoughts on Groupon quarterly results

Just finished reading the Groupon 10Q and reading the analyst slides.  I wonder how many analyst or pundits actually read the 10Q versus just listening to the company spin in the conference call.  Maybe that is expecting too much. 

Last Friday, I said that Groupon would report/spin favorable Q1 results and the short sellers would be squeezed into a pop on the stock.  If you had bought the stock friday and sold monday on the short squeeze you would have made almost 40%.  Today, as the news sets in and people actually read the 10Q, the stock is trading back down.  Here are a couple observations from my reading of the 10Q that may explain some of this.

1.  Margins are down.  1Q11 gross margin (gross billings/GAAP revenue) was 44.16%, in 1Q12 it is 41.25%.  Margins generally in Groupon Goods are lower so as that business grows, margins decline, and margins in traditional local offers are getting squeezed by competition. 

2. lower marketing spend is slowing growth.  In Q111 when Groupon spend 54% of their revenue on customer acquisition, the active customer count increased 49%.  In Q112 when they spend 21%, the customers only grew 9.5%.  Groupon would have you believe that lower marketing spend and increasing revenue mean margins are going to improve. This has not happened.  At this rate of marketing productivity decline, you could see marketing spend go to 10% of revenue and growth go to zero (only flat customer numbers to replace churning customers).  That is where this is headed in my mind.  10-15% marketing spend, flat customer growth.

3. in Q112 despite huge revenue and billings growth, they only increased shareholder net asset value by $16M ($701M to $717m).  All those sales and expenses are not improving shareholder assets.

4.  While Y/Y marketing expense was down $230M-$116M, Y/Y SG&A was up EVEN MORE $142M-$283M.  Makes me wonder if the accountants are reclassifying marketing as SG&A in and attempt to keep the party line about lower marketing expenses going. I wouldn’t be surprised by another “restatement” in the near future.

5. Not only are the gross margins deteriorating (see #1), even more concerning, the NET margins are deteriorating Y/Y very rapidly.  I suspect this is in large part due to the higher cost of Groupon Goods shipping, warehouse, etc.  Q111 net margin (cost of revenue/ Revenue) was  39/295 = 13.22%.  Q112 net margin was 119/559 = 21.28%.  Ouch, so as Groupon grows, the cost of running the company is increasing faster than their revenue and margins are shrinking.  That only ends one way.  zero. 

6. Hidden returns numbers. There has been a lot of reports in the press about increased returns at Groupon, especially in Goods. There is no way in the 10Q to figure out the size, shape of the return issue. It looks like they are hiding it, so I am sure investors are nervous.  They fear another restatement based on hidden returns liability.  The company does admit in the “restatement” on page 10 that part of the increase in cost of revenue is from putting the returns over there instead of in marketing.  So yea, marketing is down, but the costs are still there, they are over in cost of revenue and SG&A. 

7. More insider dealings.  On page 22, as part of the expansion into Groupon Goods, the company entered into an agreement with Echo Logistics, Inc. “echo”, a company co-founded by three groupon guys including chairman of the board Eric Lefkofsky.  Given how much Eric has pulled out of Groupon ahead of current public investors, more insider dealings like this are giving some investors stomach aches. 

8. No comments on where growth is going to come from or separating out Now/Goods, Travel or any other business. Believe me if those businesses were growing and giving great margins, they would be called out.  The fact they are not tells shareholders they are underperforming.

Summary:

Groupon is maturing, slowing and trying to expand but it is not going well.  They are moving from High margin business (local offers) into low margin business (products).  Contrast that to Amazon going from low margin (products) to high margin (Cloud and Amazon local).  Amazon is being rewarded for margin growth, Groupon is being punished.  Despite the revenue growth, cost remain too high and are increasing faster.  I expect growth to slow and profits to be down next quarter.

Posted by Martin at May 18, 2012 1:56 PM

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