The once beaten-up Internet 2.0 stocks are coming back with a vengeance. Groupon (Nasdaq:GRPN) still has a long way to go to match Facebook (NYSE: FB) and Yelp (Nasdaq:YELP) in terms of reclaiming prior highs, but the stock has quadrupled from its lows and analysts seem considerably more positive about the company's strategy now. With that big recovery in the stock, valuation is getting more demanding but if Groupon can get to double-digit revenue growth, I would expect the stock to remain strong.
Progress in Q2
Although Groupon's second quarter financials don't necessarily look very strong on the first look, there were multiple signs of encouraging progress on some of the company's major isuses.
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Revenue rose 7% and barely beat expectations, but obviously that's better than a miss. Gross billings were up 11% (constant currency), with 30% growth in North America. Although billings in Europe were up only 4% and rest-of-world billings were down 16%, the Street isn't nearly as concerned about the international operations at this point. Although the take-rate (ex-direct) continues to decline, that's not surprising as the company transitions its model and focus.
Gross margin dropped about 13 points this quarter, which looks bad but was pretty much in line with expectations. Likewise, the 41% drop in operating income looks poor, but it was better than expected. Likewise, the company's CSOI dropped 18%, but was about two-thirds higher than the average estimate.
Mobile Continues To Strengthen, And The New Model Could Have Legs
Whether it's Facebook, Google (Nasdaq:GOOG), or Yelp, investors are obsessed with mobile these days, and Groupon continues to grow that metric, with half of North American transaction now mobile (up from about 45% in the prior quarter).
More importantly, the company's transition to a “Pull-based” model seems to be going well. Instead of deluging customers/subscribers with daily emails, Groupon has instead been building an inventory (the Deal Bank) of discounted goods and services that customer can use on their schedule. Not only has this reduced daily deal fatigue, but it appears to be leading to a smoother demand curve for the company's merchant clients as well. In other words, everybody's happier.
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It's going to take time to build this inventory further, but management has sounded pretty confident about the “on the ground” competition they're seeing. Living Social is still out there and the barriers to entry are relatively low, but the more Groupon can grow its Deal Bank, the harder it will become to compete with the company.
Will Bigger Rivals Step Up?
I'm frankly surprised that Google and Amazon (Nasdaq:AMZN) aren't targeting this same sort of “deal inventory” market opportunity. Both Google and Amazon have the leverage to make that model work, and Google clearly wants to build its e-commerce efforts. Seeing as both companies are seemingly trying to do everything else under the sun, this gap strikes me as a little unusual and perhaps a threat were either company to decide to compete more directly. Then again, Facebook, Yelp, and OpenTable (Nasdaq:OPEN) all decided they had better things to do (though that was back in the daily deal era), so perhaps Groupon has more room and leverage than is obvious to me.
The Bottom Line
With the CEO position now filled and the company back on its feet in terms of North American billings growth, there's more room for better revenue growth, earnings leverage, and positive revisions. A long-term free cash flow growth rate of 15% is no longer enough to generate a compelling fair value target for these shares, but if Groupon is truly back in the good graces of growth/momentum investors, it won't matter to the stock's performance in the short term.
Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.