When I first discussed Groupon ($GRPN) in “Groupon Goods… Good for revenues, not for profits” it was clear to me that the transformation of Groupon would not be good for the company’s profits. (The stock is down >50% since.)
After this past week’s earnings, (and subsequent 10-Q filing), it’s also clear to me that the company doesn’t care, and current management has made the decision to become a “Goods company”.
Take a look at these numbers…
|Three Months Ended 9/30/2011||Three Months Ended 9/30/2012||Y/Y Change|
|Cost of revenue||$68,046||$181,786||167.15%|
|Total operating expenses||$430,400||$543,114||26.19%|
|(Loss) income from operations||(-$239)||$25,438|
Let’s first focus on the revenues.
Third party revenues (again measured in NET revenues (which is very important - see last post)) were actually down year over year! Clearly indicating that the companies traditional source of coupon based revenues has stalled. This quarter’s Third party revenues also included a one-time $18.5M increase, making the quarter look even better than it actually was.
From the 10-Q: (All emphasis my own)
Third party revenue decreased by $4.9 million to $417.2 million for the three months ended September 30, 2012, as compared to the three months ended September 30, 2011. The decrease in third party revenue is due to the increased focus on promoting deals in our Goods sales category, which are primarily classified within direct revenue.
We recognized a one-time increase of $18.5 million to third party revenue from unredeemed Groupons, net of applicable taxes and customer refunds, during the three months ended September 30, 2012. This one-time increase represents the cumulative impact of deals in Germany for which, based on a recent tax ruling, our obligation to the merchant would have ended prior to the beginning of the current quarter. For merchant payment arrangements that are structured under a redemption payment model, we retain all of the gross billings from unredeemed Groupons. We record revenue from unredeemed Groupons and derecognize the related accrued merchant payable when our legal obligation to the merchant expires, which we believe is shortly after deal expiration in most jurisdictions for which use a pay on redemption model. However, we have historically concluded based on our interpretation of applicable German law that our obligation to merchants in that jurisdiction extended for three years. Due to the German tax ruling, which will require us to remit value-added taxes (VAT) earlier on unredeemed Groupons, we began recognizing revenue from unredeemed Groupons in Germany shortly after deal expiration in the current period, consistent with most other jurisdictions in which we pay on redemption.
Direct revenues (measured in GROSS revenues) on the other hand has been growing like gangbusters. Obviously year over year from a base of practically zero, but even more than doubling since last quarter!
Direct revenue was $145.0 million for the three months ended September 30, 2012, as compared to $7.2 million for the three months ended September 30, 2011, due to the launch of Goods in the second half of 2011. We expect direct revenue deals to continue to grow, both overall and as a percentage of total revenue, through the continued growth of our Goods category. In addition, we expect that any growth in direct revenue will result in a smaller percentage increase in income from operations than third party revenue because direct revenue includes the entire amount of gross billings, excluding taxes and net of estimated refunds, while third party revenue, which is net of the merchant’s share of the transaction price.
In other words, if you thought our margins were bad until now… fear not – we know they were, and we’ve decided to shift our businesses mix further so they’ll get worse.
Why are the margins worse in the Goods category? Let’s take a look at the breakdown of the 167% increase in the Cost of revenues…
|Three Months Ended 9/30/2011||Three Months Ended 9/30/2012||Y/Y Change|
|Cost of third party revenue||$62,301||$54,123||-13.13%|
|Cost of direct revenue||$5,707||$127,613||2,136.08%|
|Cost of other revenue||$38||$50||31.58%|
|Total cost of revenue||$68,046||$181,786||167.15%|
Can you spot the culprit?
Cost of revenue increased by $113.7 million to $181.8 million for the three months ended September 30, 2012, as compared to the three months ended September 30, 2011, and was primarily related to the growth in direct revenue. The increase in cost of revenue was primarily driven by the cost of consumer products and associated shipping costs related to direct revenue deals, which were not significant during the three months ended September 30, 2011, partially offset by a decrease in refunds for which the merchant’s share is not recoverable related to our third party revenue deals.
Also keep in mind, not only does this business have more costs, it also entails more risks & has significantly more and well-funded competitors.
The only bright spot these last quarters has been the decrease in Marketing spend. I believe this is a result of management’s clear realization that the traditional coupon business isn’t the future, and their (ponzi style) huge growth in revenues from that division had to come to an end. (I’m not sure that supplementing it with lower margin / more risky revenues is the right more however.)
SG&A increase was mostly effected by wages & benefits. As the stock price has come down, the more this segment should be effected by cash salaries vs stock based compensation.
Where some Bulls are mistaken.
Unlike Zynga (who many put in the same boat as $GRPN), whose tangible book value is extremely important (see my $ZNGA Long Thesis here), and I think has an ample cash cushion, $GRPN does not. Yes, I know they officially have $1.2B in cash & equivalents (~1.83 per share), but $573M of that is owed to merchants, (ponzi style,) and another $245M is set aside for things like refunds & subscriber rewards. All in all, when you look at the company’s balance sheet, their current assets only exceeds their current liabilities by a little more than $300M (or .47 per share).
Another argument that some bulls argue, is that cash flow from operations is still positive. This brings me to this whole ponzi style business that I’ve mentioned a couple of times. The company pays its merchants 30 to 60 days (on average) after they collect the revenues. So as long as the business continues to grow, this gives the company more and more cash flow. It also give the company more and more liabilities.
The reason this is so crucial at this point, is because as we’ve clearly seen the company has been slowing down this business. They are spending less in marketing it, and more than all of their revenue growth this quarter came from the Goods division. So what happens when this ponzi reverses? You’ll start seeing working capital working against them and their cash balance and positive cash flows disappear.
Bottom Line: I think the company was stuck between a rock and a hard place. The coupon business wasn’t working, and although the ponzi style growth earned them a hyped IPO, and an astronomical valuation, people have started reading through it. But if the company were to just slow down, and try to turn that business profitable, 1 – their revenues will decline, & 2 – the working capital ponzi will reverse, and result in major losses. So the company’s solution – build revenues from the Goods category which will enable them to sustain double-digit overall revenue growth, and although it won’t help profits, maybe it can extend their life by some what. Perhaps. If you asked me however, I think they have a better shot turning around the coupon business than to compete in a cutthroat business with the likes of Overstock.com.