Groupon Inc (GRPN): A Bad Deal For Merchants & Investors

Groupon Inc (NASDAQ:GRPN)Shares of Groupon Inc (NASDAQ:GRPN) recently plunged again, after analysts from Piper Jaffray announced that they were expecting the group discount site’s revenue outlook for the June quarter to miss estimates. To make matters worse, Groupon announced that Faisal Masud, the VP and GM of Groupon Inc (NASDAQ:GRPN) Goods, was leaving the company to possibly join office supply giant Staples.

Masud’s departure was disappointing for investors, since Groupon Goods, its e-commerce arm for discount goods, had been considered one of the company’s only remaining bright spots. Masud’s departure comes only two months after the company fired its founder and CEO, Andrew Mason.

Is it time for investors to simply give up on Groupon Inc (NASDAQ:GRPN), which has plunged 45% over the past 12 months, or is there some flicker of hope left in this deeply troubled company?

Groupon Inc (GRPN): Going, Going, Gone...

Can Groupon Goods succeed?

Groupon Inc (NASDAQ:GRPN) Goods was started two years ago, and is the company’s first push into the realm of traditional e-commerce that, Inc. (NASDAQ:AMZN) and eBay Inc (NASDAQ:EBAY) have long dominated. Groupon Goods sells discounted products separately from its local coupons business.

Last month, Groupon Inc (NASDAQ:GRPN) announced that Goods had an annual run rate of $2 billion in global billings, or 37% of Groupon’s total gross billings of $5.38 billion. Former CEO Mason had stressed the importance of Goods on the company’s margins during the company’s fourth quarter earnings call.

Masud was a former, Inc. (NASDAQ:AMZN) and eBay Inc (NASDAQ:EBAY) executive who was hired by Groupon Inc (NASDAQ:GRPN) in 2012 to help expand Groupon Goods into a larger e-commerce community, which the company’s executives aspired to be a “searchable marketplace” on par with Amazon or eBay.

While the growth of its e-commerce arm might be good for Groupon’s top line, striving to become the next, Inc. (NASDAQ:AMZN) or eBay is a lofty and costly goal. Yet over the past year, Groupon’s expenses have been more tightly controlled, and revenue growth has outpaced expenses by a wide margin.

Groupon Inc (GRPN): Going, Going, Gone...

However, Groupon’s expansion into e-commerce shows that it knows that its primary business model of daily deals and coupons has no real competitive barriers. Since its inception in 2008, a large number of Groupon Inc (NASDAQ:GRPN) clones, which have closely replicated its business model, have appeared.

Fierce competition

Although Groupon’s initial foray into e-commerce hasn’t made much of a dent in Amazon or eBay Inc (NASDAQ:EBAY)’s market share, it has attracted some unwanted competition. Amazon’s Local Deals have recently evolved into AmazonLocal, a dedicated site for local deals that closely mirrors Groupon Inc (NASDAQ:GRPN).

In addition,, Inc. (NASDAQ:AMZN) has 209 million active users compared to Groupon’s 41 million, and Amazon is generally more trusted than Groupon by both shoppers and investors. Amazon also owns LivingSocial, another local deals site which will inevitably be integrated into AmazonLocal in the future.

eBay also entered the daily deals market last year when it rolled out Daily Deals, which focuses on physical products, and Lifestyle Deals, which focuses on dining and services. These services are all tied back to its main auction site, which are all integrated into its PayPal payments system.

Ancillary, not primary

What, Inc. (NASDAQ:AMZN) and eBay Inc (NASDAQ:EBAY) have shown investors is that a local deals business is better when its an ancillary business segment, rather than a primary one. Although Amazon has been notorious for producing rather small profits off of monstrous revenue growth, the key to the company’s success is its self-sustaining revenue growth. To date, no company has been able to touch the company’s dominance in e-commerce, which means that just like Wal-Mart Stores, Inc. (NYSE:WMT), Amazon’s profit growth and margins aren’t that significant as long as the top line keeps growing.

Meanwhile, eBay has been able to achieve higher profitability than Amazon by focusing on PayPal, its most successful business segment. In addition, its dominance of the consumer-to-consumer auction market has given it a market that is somewhat separated from Amazon’s world. Therefore, it was easy for both companies to expand from their mainstream positions into the niche world of daily deals.

Groupon Inc (NASDAQ:GRPN) has to do the opposite, unfortunately, and climb out of its niche market to challenge a mainstream one that is already dominated by two major players.

A bad deal for merchants

For many merchants, Groupon is considered as a raw deal. Although Groupon claims that it is a free way to promote services and goods, merchants are required to offer a steep discount of 50% or more. The revenue is then split in half with Groupon Inc (NASDAQ:GRPN), which leaves the merchant with only 25%, meaning that it just sold a product at a 75% discount.

What’s worse, Groupon doesn’t pay merchants right away despite collecting their share of the revenue instantly. Merchants have repeatedly complained about a “payment lag” of up to 60 days, which have led to questions regarding the company’s financial health.

Meanwhile, an alternative for merchants would be to sell their products at lower discounts through Amazon, and receive their payments on time. For Amazon, crushing Groupon Inc (NASDAQ:GRPN) would be easy – it simply has to treat merchants better.

Google Inc (NASDAQ:GOOG), through its own site, Google Offers, has already addressed Groupon’s primary weaknesses by paying out 80% of the merchant’s share of the voucher revenue within four days of the sale, and the remaining 20% within 90 days. It also pays merchants for sold vouchers that are not redeemed, while Groupon does not.

For merchants, the choice of dealing with Amazon, eBay Inc (NASDAQ:EBAY), Google Inc (NASDAQ:GOOG) or Groupon comes down to whichever company offers the better deal. Amazon, eBay and Google Inc (NASDAQ:GOOG) can afford to offer more attractive packages, which Groupon will find increasingly tough to match.

A bad deal for investors

Although Piper Jaffray expects weak revenue guidance for the March quarter, it expects in-line top and bottom line results. However, Piper maintains an ‘overweight’ rating on the stock, stating that international and “take rate” (percentage of revenue kept by Groupon for sold products and services) stabilization could offset some of the negative guidance.

However, I believe that investors shouldn’t have too much faith in Groupon. The company has been mired with accounting problems, such as its embarrassing earnings revision last March when a higher-than-expected number of customers requested refunds.

With so many high-profile departures over the past year, it also appears that the company does not have much faith in itself. Co-founder Eric Lefkofsky and board member Ted Leonsis are currently the interim-CEOs until the company can find a suitable replacement for Andrew Mason.

The Foolish Bottom Line

With a negative profit margin of -2.35% and a bleak -7.07% return on equity over the past 12 months, you should only invest in Groupon if you have faith that its business model of daily deals can actually grow.

When an e-commerce company has lost credibility with its merchants, investors, and own executives, it’s time to move on. Bigger players such as, Inc. (NASDAQ:AMZN), eBay Inc (NASDAQ:EBAY) and Google Inc (NASDAQ:GOOG) will inevitably gobble up Groupon’s daily deals market by offering merchants more attractive terms, and customers will follow. In other words, Groupon is toast.

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