Thursday, November 15, 2012

This Discount Marketplace is No Discount for Investors

Everybody would like to purchase goods and services at a discount. That is why the discount marketplace business has become more and more popular. However, those businesses might face difficulties in the future due to increasing competition. Groupon (NASDAQ:GRPN), a leader in this field, had been a stock market darling, with the stock price as high as $26 in November 2011. However, the stock has experienced a downward spiral, with Groupon gradually declining to only $2.69 now, one tenth of what it was trading for one year ago.
Groupon created a discount marketplace, where it negotiated good deals with merchants, then offered those deals to customers in the form of discount coupon. In this value chain, all three parties benefit. Merchants can rely on this for both sales and marketing for their products and services. Customers can use those products and services at a deep discount. Of course, Groupon would get the benefits with its intermediary services too.
Recently, the company announced its better than expected results for Q3 2012. Its revenue was nearly $569 million, a 32% year-over-year growth. The impressive double-digit growth was due to an increasing number of active customers. Its EPS improved from a loss of $0.18 in 2011 to break even this year. Notably, the weighted average basic shares outstanding doubled, from 308 million shares last year to more than 653 million shares this year.
Andrew Mason, Groupon’s CEO is quite optimistic about the company’s future:
“Our solid performance in North America was offset by continued challenges in Europe. Groupon Goods have evolved into a second major category that our customers clearly love. With deals on everything from designer sunglasses to big-screen televisions to most-wanted toys, we think it will be a great gifting destination this holiday season.” 
As of September 2012, Groupon had nearly $800 million in stockholder equity, no debt, and $1.2 billion in cash. Out of $1.23 billion in liabilities, the accrued merchant payables and accrued expenses were $573.5 million and $245 million, respectively.
Even with the impressive growth in Q3, investors are still pessimistic about Groupon; after all, the growth is just an improvement from a loss to a break even. Furthermore, it is a “low barrier to entry” service business. That is why even though the industry is quite trendy, it is hard for investors to pick the winner in the long run. Groupon has been a leader because it has a wide coverage of merchants to offer the best deals to customers. It has the fixed price, which is valid until a certain amount of customers accept the deal. For merchants, Groupon doesn’t charge fees for marketing services; it instead made its money by taking a percentage of each coupon it can sell.
Unfortunately, competitors including LivingSocialTravelzoo (NASDAQ: TZOO), andAmazonLocal, a partnership between LivingSocial and Amazon (NASDAQ: AMZN), have been fighting to take market share from Groupon. According to Yipit, in the North American market Groupon’s market share fell to 53% in Q2 this year, 3% lower than the previous quarter, whereas LivingSocial was up 2% to 22%. Travelzoo moved up a little to 3% of the total market, and AmazonLocal took 2% of the market.
Even with a much smaller market share, AmazonLocal has tremendous advantages, as it is a combination of LivingSocial and Amazon. It can leverage the huge customer database and relationship of Amazon and use its parent's reputation to build the business. With its fame, Amazon is a company that merchants love to attach their names to. By cooperating with AmazonLocal for their deals, consumers might have a perception that the merchants have been endorsed by Amazon.
Groupon is trading at $2.69 per share; the total market capitalization is $1.76 billion. Over the past twelve months it has been generating losses, so its P/E ratio is not valid. The market is valuing Groupon at 2.3x its book value. Its smaller peer, Travelzoo, is generating profits. It is trading at $17.61 per share, with total market capitalization of $278.25 million. The market is valuing Travelzoo at 13.6x P/E and 5.9x P/B. It seems to be reasonably, priced with its PEG ratio of 1.0x.
My Foolish Take
Groupon is still the leader in the industry, but other competitors are fighting back vigorously to bite more shares of this market. It is hard to predict what would happen in the future. The industry will be prospering, but nobody knows who will come out as a winner in the future. I would rather stay away from all these companies for now.

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