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Morningstar | Groupon Missed 2Q Expectations, but Hinted It May Be an Acquisition Target; Shares Fairly Valued. See Updated Analyst Note from 04 Aug 2018

Groupon's second-quarter results came in below our expectations and consensus due to decline in North America billings and revenue. While impact of lower than expected revenue on the bottom-line was partially offset by slight gross margin expansion, lack of top-line growth is likely to continue as indicated by management’s disappointing third quarter guidance. We note that the firm’s full-year 2018 adjusted EBITDA outlook was unchanged, which we think is based on the success of the roll-out of higher-margin Groupon+. While Groupon is now focusing more on retaining customers rather than acquiring new ones, which partially explains the revenue miss, in our view, lack of a network effect moat source will likely force Groupon to continue increasing its marketing spending, lessening the likelihood of the firm generating excess return on capital in the long-run. Despite the slightly lower than expected second quarter results, we are maintaining our Groupon $4.60 per share fair value estimate and continue to believe the shares of this no-moat and very high uncertainty name are fairly valued as they trade in 3-star territory.

Gross billings during the quarter declined 7% from last year, mainly due to less than expected net customer additions. Groupon ended the quarter with 49.3 million customers worldwide, up 2% year-over-year, but down nearly 1% from first quarter. With total revenue of $617 million during the second quarter, Groupon’s take rate was flat year-over-year, but did inch up 1 percentage point to 49% from last quarter.

Slower user growth and flat take rate were partially offset by higher gross profit generated per user, which went up 3% from 2017, and 0.4% from last quarter. While we think the launch of higher margin Groupon+ drove the sequential increase in take rate and overall increase in gross profit per user, we remain convinced that the firm must continue to spend more on customer acquisition, on maintaining a higher percentage of its current customers, and on enticing them to buy more goods and services more often, as the firm lacks the network effect moat source. We do foresee some return on that spending as we continue to expect top-line growth beginning in 2019, albeit single-digit growth only. We have modeled a 3%-plus average annual revenue growth for the next five years.

Thanks to Groupon+ and a better mix of products and services sold, gross margin increased to 52%, up nearly 200 basis points from second quarter 2017. SG&A shot up 28% year-over-year and came in at 48% of revenue, mainly due to the $75 million that Groupon recognized as expenses related to a patent infringement case that the firm lost recently to IBM. Excluding that, SG&A represented 35% of revenue, similar to last quarter and 2017. While marketing spending declined sequentially and year over year, it continued to represent 15% of revenue, up only 10 basis points year over year. Without the impact of the IBM case and excluding $399,000 in restructuring charges, Groupon expanded operating margin by 3 percentage points from last year to 2%. We foresee margin expansion going forward driven by growth in usage of the firm's new offerings such as the higher-margin Groupon+, and Groupon's further cost control on SG&A. We are assuming operating margin to widen to nearly 6% by 2022, from a mere 1% in 2017. However, we don't believe that Groupon has carved out an economic moat or a sustainable competitive advantage and, in turn, may struggle to generate healthy top-line growth and margin expansion in the long run.

Last, in response to a question related to some recent rumors that Groupon may be looking for a buyer, management hinted that some potential buyers have shown interest. However, if there are any bids, we think it is less likely that they will be more than 10%-15% above our fair value estimate of this no-moat name, which lacks strong revenue growth. Our $4.60 fair value estimate represents 0.7 and 7 times 2019 EV/Sales and EV/EBITDA, respectively.