Buy, Sell, or Hold: Groupon


When considering any stock for your portfolio, don't be swayed by just the positives. Examine its pros and cons, and decide whether it's possible upside outweighs its risks. Let's take a look at daily deal specialist Groupon (NAS: GRPN) today, and see why you might want to buy, sell, or hold it.

Founded in 2008, based in Chicago, and sporting a market cap a bit above $3 billion, Groupon is in the connects businesses with customers by emailing special deals to its large list of subscribers.

The stock debuted via an IPO last year, and saw its shares quickly rise from $28 to $31. They've gone in the other direction ever since, though, and recently traded around $5 per stub.

Clearly, the stock has been beaten up badly, and in such situations, there are usually some compelling buy reasons. Still, at some point, some imploded stocks can actually be attractive, if their problems are deemed more temporary than permanent. So why might one consider buying Groupon? Let's see...

For one thing, it's capable of great growth. Revenue in 2009 totaled $15 million, and over the past 12 months, it totaled almost $2.1 billion. It has actually been posting positive (and growing) free cash flow as well. In 2009, it reported $7 million in free cash flow, and over the trailing 12 months, that has become $316 million. Cash has been growing, too, from $14 million in 2009 to $1.2 billion by the end of June.

Its active-customer count rose 65% between last year's second quarter and this year, to 38 million. During the same period, marketing costs, which worry some investors, fell from 54% of revenue to 15%.

The company is busy innovating and trying new ways to boost its service to customers and its business performance. Its new "Merchant Center," for example, gives its customers more tools with which to manage their Groupon campaigns. Its Groupon Getaways is a travel partnership with Expedia.

Another thought is that the company might end up getting bought out by another, for a premium price that would reward shareholders. This is mere speculation, though.

Finally, some see the stock as a bargain when they look at certain numbers, such as its price-to-free-cash-flow ratio, where it was much stronger at a recent 6.3 than Facebook's (NYS: FB) 71.9 or Zynga's 28.4.

To me, the main reason to sell or steer clear of Groupon is its business model. It does enjoy some economies of scale, given its size. But whereas a company such as eBay (NAS: EBAY) can double its revenue without doubling its workforce or other costs, as its online system can scale up relatively easily to handle more traffic, Groupon relies on a hefty and growing team of salespeople signing up businesses to offer deals. For it to offer many more deals, it needs to employ more salespeople. That's more capital intensive than, say, LinkedIn (NAS: LNKD) or Facebook. Indeed, Groupon's employee count has surged from a handful of people to more than 10,000 over just a few years. When Facebook went public this year, it had about 3,500 workers. At the end of March, LinkedIn had 2,447. Zynga's headcount was recently north of 2,800.

Then there's competition, from LivingSocial, in which has a big stake, and from many others, including Facebook, AOL, Google, and others. There just isn't much keeping many companies from offering similar services, and it's not the kind of business where customers are likely to remain loyal to just one service.

Some other numbers aren't ideal. Gross profit margins, for example, have been shrinking. The company's revenue growth rate will inevitably slow, as will the rates of other fast-growers such as Facebook and LinkedIn. That's simple math -- huge growth rates are not sustainable over the long haul.

The stock's fall is a real concern, too, because it can hurt the morale of employees, especially those holding lots of stock options. Some companies with falling stock prices have been working hard to try to retain their talent. Zynga, for example, is offering equity grants to workers. If Groupon does something similar, it could be costly.

Accounting issues have been another concern for Groupon, though some are now satisfied that things are under control with a new head of accounting coming from a big accounting company.

The company hasn't been loading up on debt to generate funds, but it has been issuing a lot of additional stock. There were 362 million diluted shares outstanding at the end of last year, and 663 million by the end of June. When companies significantly increase their number of shares outstanding, it dilutes the value of existing shares, hurting shareholders. Thus, while earnings might rise, your claim on earnings is shrinking.

Another concern is insider selling by some early investors like Marc Andreessen. Insider selling isn't always a sign of doom, since many investors are simply generating cash they need or want for other purposes.

Hold (or hold off)
Given the reasons to buy or sell Groupon, it's not unreasonable to decide to just hold off. You might want to wait for it to spend a few years as a public company and see how it fares. You might want to see how it deals with its competition, and how successful its new ventures are. You might also keep an eye on its subscribership and growth rates.

The verdict
I'm steering clear of Groupon, myself. It may perform spectacularly in the coming years, but there are plenty of compelling stocks out there. Everyone's investment calculations are different, so do your own digging and see what you think.

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