Revising Groupon To $4 On Higher Marketing Costs Outlook And Slower Revenue Growth

Groupon‘s (NASDAQ:GRPN) stock has taken a beating after the announcement of its Q3 results and dipped below $3 before recovering more recently. The stock fell because of its struggling European business and lower margins. Groupon’s margins are much lower this time around and its cost of revenue has nearly tripled y-o-y due to its new business line Groupon Goods and due to the fact that it is selling more expensive deals. The total cost of revenue went up from $68 million to to $181 million y-o-y while revenue grew at a much slower pace from $430 million to $568 million.

The company missed its lowered revenue guidance on slow growth mainly in the ‘International Deals’ business. It had released an outlook for Q3 2012 and expected revenue to be between $580 – $620 million, an increase of 35-44 percent y-o-y. It missed this guidance and reported consolidated revenues of $568.6 million, up 32 percent y-o-y. Operating income came in at $25.4 million, compared to an operating loss of $0.2 million during the same quarter last year.

Based on guidance provided on long term cost trends, we have revised our valuation, which is explained below. ^[1]

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Changes To Our Valuation

The biggest challenge for Groupon is its international business which grew by only 3 percent y-o-y to $276 million. The company has had issues with the international business for the past few quarters, and we have revised our estimates to match the slower growth it has been showing.

Groupon also released an outlook for Q4 2012 and expects revenue to be between $625 – $675 million, an increase of 27-37 percent y-o-y. Income from operations for Q4 2012 is expected to be between $0 to $20 million, compared with a loss of $15 million in Q4 2011. As it streamlines its international business along the lines of its North American business, we can expect revenues to grow.

The company has succeeded in reining in its customer acquisition costs, but the SG&A costs have gone up by 50 percent y-o-y to $290 million. We will keep an eye on this metric in the coming quarters. The dropping marketing expenses suggest that the brand is becoming stronger with its customers, but these gains are being eroded by the climbing SG&A expenses. We have updated our model to be more in-line with this trend.

The company has guided that marketing expenses in the long run will remain at 20% of revenues, and our valuation of the stock modeled a decline in marketing expenses as a percentage of revenue to a high single digit value previously as we anticipated greater operating leverage as the company grew. We have revised it to fall to 20% and remain constant in the latest model in line with the company’s guidance.

With falling revenue growth and rising marketing, selling and general costs, we now expect the stock to be worth significantly less than we previously expected until we see more encouraging signs that the company can provide growth in its international business and stabilize its cost base. We currently have a $4 Trefis price estimate for Groupon, which stands near its current market price.

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1. Groupon SEC Filings, www.sec.gov, Nov 8, 2012 [↩]