June 10 2020 - Groupon Is A Buy For A Patient Investor

After quarters of losing to competition in the Goods segment, Groupon finally made the decision to exit Goods and focus on local experiences, which consumers turn to after COVID-19.

Groupon has a new management team, which is committed to deliver on a new strategy. The company has launched a poison pill to fend off hostile take overs.

Groupon's shares are hugely undervalued and can more than double in the next year.

Groupon's (NASDAQ:GRPN) stock has lost almost 60% of its value in the past couple of months and now represents an attractive buying opportunity with the investment horizon of more than one year.

Groupon's sales have been on decline for the past 3 years. The company missed its own 2019 EBITDA guideline and the management announced the decision to exit the Goods category, which accounts for 50% of sales, by the end of 2020. All these news combined have resulted in sharp share price drop, declining by almost 50% in one day from .05/share to .7/share. We believe that the stock market has overreacted and Groupon has a good chance to deliver profitable growth in the future.

Groupon is punished for the right decision to exit Goods

Historically Goods category has been a low-margin business for Groupon, however, it served to attract customers to the platform and cross-sell other categories. In 2019 Groupon delivered a meager 16% gross profit margin in Goods in comparison to almost 90% gross profit margin for Services. The gross profit margin for Goods has been declining over the years as the company got squeezed by the larger competitors, such as Amazon and the consumer tastes changed to faster shipping expedience, on which Groupon could not deliver.

Management's decision to let go of Goods was the right move, which will allow the company to focus on developing Services category and local experiences as the more profitable part of the business.

Actually, COVID-19 might even help Groupon to execute on its strategy as the consumers become aware of the fragility of local businesses and communities and 75% plan to make conscious effort to support them.

What Groupon needs to achieve to execute on its strategy

The first priority should to increase the bookability of its offers. If you look at comparable services, such as Airbnb Experiences, there you can book the offer immediately. Currently 65% of Groupon's international dining inventory is bookable, however, when it comes to beauty & wellness, the percentage is very low. Often it requires an additional step, such as making the appointment by calling the service provider, which puts customers off in the world of one-click purchases. Groupon management has realized the shortcoming and made the increased bookability one of its priorities for Q1 2020.

The second step should be to increase the brand awareness. Groupon no longer wants to be a go-to place for cheap bargains, the company wants to be a marketplace for local experiences. Therefore, the current and especially the potential consumers need to know about it.

As Groupon will lose its Goods customers by the end of 2019 it will need new channels to attract new users, since a large portion of its consumers in the past came from goods before purchasing local services. After modernizing their app in Q2 2020, for Groupon it would be the prime time to launch an outdoor advertising campaign on city-lights, billboards etc. to make potential consumers aware of an extensive local experiences catalog available at Groupon app. So watch for Groupon outdoor advertising, which will be a sign that the company is moving in a right direction.

The third point, which should make up the backbone of Groupon's future strategy is the company's interaction with service providers. Similar to other apps it should be easy for businesses to create their offers on Groupon and manage them. Should the company be able to execute on these three major pillars, it will be able to compensate all gross profit margin lost during the exit from the goods business.

Financial Results will improve only by the year end

Groupon is to announce Q1 2020 earnings on June 16th, which are likely to be a bloodbath, due to the somewhat reduced demand for company's products and services due COVID-19 as well as the cost incurred from the ongoing restructuring plan. It will be the first results announcement for Aaron Cooper, the interim CEO and the second for the CFO Melissa Thomas. Curiously enough, Groupon's management does not plan to have an analyst call afterwards, and rather suggests individual calls with analysts. Also, the filing date for the Q1 results have been extended by 45 days.

So what can we expect? Most likely Groupon's sales continued their decline and will come just under 0m for both Goods and Services combined. That might result in net loss of m or cents per share. Market consensus for EPS currently stands at - cents.

Now we are approaching the end of Q2 and see the reopening of local service providers in the US and in Europe. Should Groupon be successful in boosting their revenues in services by 25%, it will significantly improve their gross profit margin to 70% thanks to the 90% gross profit margin for services. We expect the company to finish the year with ,8b in Revenue (-19% compared to 2019) and around 0m in EBITDA.

DCF Analysis: Groupon is fairly valued at per share

In our DCF analysis we assume a modest 5% sales growth in the years 1-10, perpetual growth of 2% and WACC of 11% to reflect the additional risk reward investors would require.

Despite our conservative assumptions, the fair value of Groupon's shares amounts to per share, which offers 166% upside to the current share price of ,51 per share.

Source: Company data, analyst's estimates

However, Groupon will be no longer a penny stock. During the AGM on June 11th Groupon's shareholders will be asked to vote for a reverse stock split of 1-for-15 to 1-for-20, with the ratio being chosen by the Board. It would mean that the fair price per share will increase to - respectively, depending on the split.

On a negative side, there are a number of class action lawsuits which have been filed by shareholders against the company. They accuse the management of not timely disclosing the information on Goods performance at the end of 2019. Groupon has lost about bn in Market Cap between November 2019 and February 2020 and some shareholders might join the class action to claim back their losses. It is currently not clear if the company would agree to any settlements.

On April 13th Groupon's Board of Directors announced the rights plan, a poison pill to fend off any hostile takeover attacks. According to the plan, should any investor acquire more than 10% or 20% of the company, all other shareholders will be entitled to purchase additional shares at reduced purchase price. We view it positive, as it would give the management a year of time to execute on the strategy and either continues as a stand-alone business or become an acquisition target at higher levels.

Conclusion

Groupon's performance in the past few years has been disappointing. However, the management has made a tough decision to exit the goods segment and focus on services. Should this strategy be even moderately successful, Groupon's share price will adjust to , or - after the reverse stock split. But it will take some time for the new management to execute the turnaround and the results will be seen in a year's time. Thus, Groupon is a good stock for a patient investor.

To watch: Groupon's brand campaign, Q1 earnings announcement on June 16th

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.