(By Rich Bieglmeier) Legg Mason Opportunity Trust fund manager Bill Miller says he likes Groupon, Inc. (GRPN) "a lot' on Friday, March 15, 2013. The money manager says he is "more attracted to stuff that has warts on it and hair and all that kind of stuff."
With $1.2 billion in the bank and in debt to nobody, Miller sees a "tremendous" opportunity as the couponer has an "enormous addressable market" with "very good data analytics" from "folks who were at Amazon, like CFO Jason E. Child.
Shares of Groupon ended Friday 6.10% on Miller's words.
So, what the deal with GRPN, warts and all? Is the stock worth owning, or will shares see further discounts? Let's do our best to answer the question.
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First of all, to understand Groupon investors need to understand their business model. There are two basic parts to the company, the Third Party and Other Revenue business and Direct Revenue.
If you were to play word association and the word was Groupon, part one is pretty much what everybody thinks about GRPN, email and online deal-vouchers that introduce vendors and customers at a discounted price. This side of the business is stable and extremely profitable.
Year-over-year, Third Party revenue grew 18.25% in 2012 versus 2011. At the same time, cost to grow revenue rose 22%, and increased slightly from 15.3% of revenue to 15.8%. Obviously, iStock would like to see the reverse happen, rising sales and lower costs increasing margins. Shrinking margins, along with flattish guidance is one of the main reasons GRPN has been demolished by Wall Street.
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However, Third Party isn't the biggest culprit for shrinking margins. That honor belongs to part two, Groupon Goods or Direct Revenue. Groupon Goods is essentially a wholesale business as the folks at GRPN headquarters in Chicago roll their eyes. Anyway, the company will buy stuff in bulk, like Toshiba big screen TVs. Management negotiates a fixed price and guarantees a certain number of TVs sold. Groupon transparently marks up the Toshiba TVs and keeps the difference.
As evidenced by no inventory, Groupon doesn't take physical possession of the acquired goods/merchandise.
In 2011, Goods did a little more than $20.8 million in revenue. That stepped up to $454 million in 2012. In most cases, Wall Street's stocks would roll up and down on those kinds of numbers, but… 2011's gross profit margin was 27.54%. It fell to 7.37% in 2012 – ouch, presto $5 stock.
In fact, Groupon Goods accounted for 58.58% of the company's total cost of revenue but represented just 19.48% of revenue – not a good mix. As we said before, margins on a diet while costs are hitting the buffet line repeatedly, along with a flattish outlook, are not the hallmarks of robust stocks. Some might call them hairy warts.
For 2013, Wall Street sees revenues of $2.55B versus 2012's $2.33B. That's 9.40% growth and not so flat and gladly taken for 100s if not 1000s of publicly traded companies, but flat and falling by GRPN's standards. To put things into perspective, we screened for companies with projected 2013 sales growth of more than 9%, and 1,600 companies qualified while 2,450 did not (not all companies have sales estimates).
Once again, we turn to our trusty screener to identify 115 companies with forecasted sales growth from 9% to 10% for the year, right where Groupon sits. The average P/S ratio for this group is 2.78 on anticipated revenue growth of 9.5%.
As we type, Groupon is trading at 1.52 times 2012 sales, 1.37 times 2013's consensus, and 1.23 times 2014's revenue forecast. In the company's limited public life, the average price-to-sales ratio (P/S) is 2.48 with a low of 0.70. Compared to its sales growth peers and history, GRPN is discounted.
As 2013 progresses, we'd expect Groupon Goods' margins to increase as GRPN should gain some pricing leverage with merchandise suppliers. If margins and sales move higher as we expect, it's our view that Wall Street will value GRPN closer to its sales growth peers and historical P/S ratio.
With a 2013 P/S ratio of two, GRPN would be priced at $7.75. Shares would be valued at $9.60 with its historical average of 2.48, and at the revenue growth peer group, $10.77.
iStock will stick with the most conservative of our estimates and put a 12-month price target of $7.75 on Groupon, Inc. (GRPN) –upside potential of 44% to the target.