Everything is relative in the stock market, and it's important to keep Groupon's (Nasdaq:GRPN) performance in context. Yes, Groupon does seem to be doing better, but bears may well argue that means nothing more than Groupon is in a better state of certain death. Although I don't think Groupon is doomed, I do think there's a lot of work left to do, and Groupon still has a lot left to do before it convinces investors that this is a real business with real value for the long-term.

SEE: Is Groupon Good For Business?

Some Improvements In The First Quarter
Expectations for Groupon have definitely seen downward revisions over the past year, but the company's first quarter results offer some optimism that management, sell-side analysts, and reality are all back on the same page.

Revenue rose 8% as reported this quarter, good for a slight beat relative to expectations. Gross billings increased 4%, as strong North American growth (up 23%) was offset by ongoing declines overseas (international down 9%). While the active customer count increased 13%, units rose only 4% for the quarter, suggesting that utilization still remains an issue.

Margins are still very much a mixed bag. Gross margin dropped more than 15 points from the year-ago period, but did improve more than seven points from the December quarter. This was true in the operating earnings as well – GAAP operating income fell by almost half from the year-ago period, but reversed a December loss. Likewise, the non-GAAP iteration saw a 24% year-on-year decline, but a significant jump from the prior quarter, due in part to a better take rate.

SEE: Analyzing Operating Margins

Competition, Fatigue, Or The Economy?
Investors have worried about Groupon and its business model for quite some time already. Facebook (Nasdaq:FB), Yelp (NYSE:YELP), and OpenTable (Nasdaq:OPEN) have all steered away from this business, and some analysts seem to think it's only a matter of time before Amazon (Nasdaq:AMZN), Google (Nasdaq:GOOG), and/or Yahoo! (Nasdaq:YHOO) drop the hammer. Along these lines, I think privately-held Valpak may be an under-appreciated long-term threat in this market.

At the same time, I have to wonder if the economy is helping or hindering this business. True, people want bargains and coupons when they're feeling squeezed, but it's not like the consumer spending data has been great recently. Very few retailers are expressing a lot of confidence yet, and data on the restaurant industry is still pretty uninspiring.

I wish I had a firm conviction on what that meant for Groupon – does it mean business will weaken as consumers feel better about spending, or does it mean that Groupon is building up a solid user base during a time of depressed spending and results will get a lot better if/when the economy improves?

SEE: Which Coupon Country Is Supreme?

What Is This, Really?
I realize that Groupon is grouped in with this latest generation of internet companies, but I'm not sure that's really the way to look at it. In many respects, I see this as a business services company (not totally dissimilar to Vistaprint (Nasdaq:VPRT) or Constant Contact (Nasdaq:CTCT)) that happens to use the internet as the vehicle for the services it provides. To that end, it's all about costs and the cost/benefit that Groupon offers both customers and client companies.

Along those lines, analysts seem to be celebrating the improved mobile penetration in North America (from 40% in Q4 to 45%), but I'm not sure that builds any sort of lasting edge. Instead, I think it's just an essential part of staying relevant. Likewise, the expansion into new lower-margin verticals carries the risk of more volatility for the stock, as investors trade off the near-term margin impact and the longer-term benefits to grabbing a greater “wallet share” with users. I also do wonder whether the 200 or so on-the-ground Valpak franchises hint at the sort of investments Groupon may need to make in the future to really stay in touch with local businesses.

The Bottom Line
I still think Groupon is likely undervalued, but I have no particular desire to own these shares. If the company can grow its free cash flow (FCF) at long-term rate in the low-to-mid teens, a fair value of around $8 seems reasonable today. That said, I do view this company as a provider of marketing services to primarily small, local businesses and I've seen enough of those businesses come and go to realize how volatile that market can be. As such, I'd need a pretty substantial discount to fair value to want to buy these shares with my own money.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Tickers in this Article: GRPN, FB, VPRT, CTCT, GOOG, YHOO

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