by Justin Dove, Investment U Research
Thursday, November 3, 2011
Groupon deserves a ton of credit for revolutionizing the way Americans consume.
Over the past few years, social purchasing has offered consumers discounts they never received in the past. The business model is almost like consumers forming a union to buy in bulk – purchasing power in numbers.
But good companies and sound stock investments aren’t built on brand recognition or contributions to society.
For example, take a gander over at Eastman Kodak (NYSE: EK). Kodak revolutionized the way people captured memories. But poor leadership and lack of adaptability nearly eradicated them. All that’s left is essentially a pile of patents.
But is Groupon’s IPO a buy-low opportunity on a rising star in the social media craze? Or is it a black hole of cash that can’t survive?
The Good News
There’s a reason Groupon has reportedly called off taking IPO orders a day earlier than expected. Some investors can’t wait to get their hands on the stock. Here are a few reasons why they may be bullish:
- Rapid growth in subscribership – According to its S-1, Groupon had 1.8 million subscribers at the end of 2009. At the end of 2010 it had grown to 50.58 million subscribers. By the end of March it had grown to 83.1 million. Finally, in August, Groupon announced that it had gained 38-percent more and reached 115 million subscribers.
- Diversification – Groupon added to its offerings from its core local deals to include deals on event tickets, products and vacations. These additions have helped it grow eight percent from Q2 to Q3.
- “Smart” deals – Groupon’s eventual goal is to cater its deals to individuals by preferences and locations. This is far off, but mastering this could be something that sets Groupon apart from the numerous other deals programs.
- Contrarian factor – Groupon was such a bad word with analysts over the past month that it’s possible a herd mentality is developing and people doubt it a bit more than they should.
And the Bad News
- Increasing competition – There are now a number of deals programs that mirror Groupon’s business model. With larger companies such as Google (Nasdaq: GOOG) and CBS (NYSE: CBS) in on the action, it’s unlikely that Groupon could survive a spending war. Also, considering its core audience is people looking to save money, there’s likely little brand-loyalty. The minute a better offer comes along, customers will hop onboard, regardless of the source.
- Record low float – Bloomberg reported that “only 4.7 percent of the unprofitable company’s shares will be sold to the public, less than in any U.S. Internet company IPO of more $200 million since at least 2000.” Groupon is playing hard to get with investors. It’s trying to ramp up demand by lowering supply. This will likely artificially inflate prices until Groupon needs another injection of cash and decides to offer a secondary offering.
- Core business declining – Despite Groupon’s eight-percent growth in the last quarter, its local deals revenue fell by three percent. Taking into account the growth in subscribership… It may not be a good sign that its core local deals business is already losing market share.
The Rap on IPOs In General
Here are a few things to keep in mind about IPOs in general, which also apply to Groupon’s.
- IPOs are only available to institutional investors on the first day. That means investors like you and me couldn’t cash in on a big run, like the one in LinkedIn (NYSE: LNKD), until day two.
- IPO stocks are usually priced on the low side to generate a “pop.” This possible pop in price serves to create a momentum in hopes that the shares will run up and create value for early investors. It also generates free publicity for the company.
- Usually the glory fades on IPO pops. For instance, LinkedIn created a huge buzz with its meteoric rise on its IPO date. But a month after closing at a price of $94 on its opening day, it fell to under $65. Pandora Media (NYSE: P) is another company that’s trading under its IPO pop months after it went public.
Bottom Line for Groupon’s IPO
Groupon’s long-term prospects don’t look very positive. Most analysts don’t trust the stock, and they’re right to be cautious of the unusually small float. But the sentiment is so negative that investors may be too far down on its stock.
But the report that demand is high for its pre orders seems to spell over exuberance. Plus, history tells us that the IPO pop never lasts. And Travelzoo (Nasdaq: TZOO), which is overpriced, is probably still a better value at this point than Groupon.
It’s best to take a wait-and-see approach to Groupon’s stock. Even if investors are excessively down on Groupon on its initial offering, contrarians will have some time to act before people start believing in the stock.
How Groupon handles the next sixth months will be important. To become a truly viable investment, Groupon will need to improvement its fundamentals and curb its need to infuse more and more cash. It’ll be interesting to see if it can pull off the job.