This Just In: Upgrades and Downgrades
At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
Is Wall Street too down on Groupon?
Amidst all the wailing and gnashing of teeth over Facebook's 50% plunge, early investors in Groupon (NAS: GRPN) are quietly rubbing forefinger against thumb, and asking: "You know what this is? It's the world's smallest violin, playing you the world's saddest song."
This morning, as Groupon shares quietly tumbled to their lowest level ever, analysts at Evercore compounded shareholders' misery by piling on a new downgrade. Advising investors to "underweight" the stock, Evercore warned that the bad news here is far from over. Groupon may only cost about $4.50 a share today but, according to Evercore, it could be worth even less -- a mere $3.00 a share -- within a year.
Why? Citing a slide in "gross billings" -- caused by not enough people biting on its daily deals -- Evercore warns: "We see potential for future cash burn" at Groupon.
It works like this: Groupon collects money from its users when they buy coupons for use at merchants. It only pays this money out days, weeks, or months later, when the users cash in these coupons for goods and services. If Groupon gets to a point where purchases of coupons arrive slower than redemptions of coupons already sold, then Groupon will find itself paying out more cash (to merchants) than it brings in (from customers) -- and begin burning cash. The analyst figures it would only take about a 5% reduction in the size of Groupon's business to turn free cash flow into actual cash burn.
Does this make sense?
Run the numbers
Over the past year, Groupon brought in $2 billion in annual revenues. Doing the numbers, 5% of that equals about $100 million, so, by Evercore's logic, a $100 million reduction in Groupon revenues would mark the beginning of the end for the company. But this math doesn't seem to work. For one thing, Groupon currently boasts free cash flow of about $330 million for the trailing 12-month period. On the face of it, it's hard to see how even a $100 million deceleration in revenues would be enough to turn Groupon from a cash generator into a cash burner.
Consider, too, that last year, Groupon had revenues of only "$1.6 billion." That year, Groupon did almost as well as it's been doing over the past 12-month period, generating nearly $250 million in positive free cash flow -- on $300 million less revenue than what Evercore says will be its tipping point.
Again, Evercore's assertion seems to fail the logic test.
Time to buy?
Now, mind you, I'm not saying you should rush right out and buy Groupon at today's prices. I'm not saying the stock is a "buy," period. While the shares look cheap to me at a valuation of about nine times trailing free cash flow, the hard truth of the matter is that Groupon still needs to grow at some rate in order to justify its valuation. Maybe it doesn't need to hit the 30% long-term target that Wall Street has set for it, but at least 10% annualized growth would be nice.
Evercore seems to be arguing -- and last week's earnings report supports this -- that Groupon isn't growing at all or, at least, not growing for long. Instead, the company's business, and its revenues, have begun to shrink. If it's right about that, then it's probably right to recommend avoiding the shares, too.
Foolish final thought
If you want to sell Groupon, that's fine by me. After all, as we recently explained in our report on "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail," the retail world is changing and, while we see some companies benefitting from the changes, Groupon isn't one of them.
Indeed, there are any number of valid reasons to doubt Groupon's future -- including the risk that a deep-pocketed alliance between Amazon.com (NAS: AMZN) and LivingSocial will outcompete Groupon. There's also the possibility that Google (NAS: GOOG) , which tried and failed to buy Groupon itself not so long ago, will gain traction with its Google Offers business, and sweep Groupon into the virtual dustbin of e-commerce history. Most obviously, and perhaps most valid - is the simple fact that Groupon still isn't reporting "GAAP" profits, and so the stock holds little attraction to investors who value stocks on a P/E ratio that Groupon doesn't have.
Just don't decide you have to sell based on today's advice from Evercore, or because you think the stock's about to suddenly start burning cash. It's just not going to happen -- not yet, anyway.
The article This Just In: Upgrades and Downgrades originally appeared on Fool.com.Fool contributorRich Smithholds no position in any company mentioned, but The Motley Fool owns shares of Facebook, Amazon.com, and Google.Motley Fool newsletter serviceshave recommended buying shares of Amazon.com, Google, and Facebook.You can find Rich on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 261 out of more than 180,000 members. The Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.
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