What a difference a decade makes. Unlike the "what, me worry?" attitude that dominated the prior tech bubble, investors seem considerably more interested in the immediate financial performance of companies like Facebook (Nasdaq:FB) and Groupon (Nasdaq:GRPN). With Groupon once again disappointing the Street, it looks like management needs to rebuild its credibility with institutions, even if the long-term growth story looks interesting at these prices.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

Second Quarter Results Feed Bulls and Bears Alike
By no means did Groupon report a clean second quarter, but then again neither was it a disaster.

Revenue rose 45% as reported (about 53% in local currencies), missing estimates slightly on disappointing international growth. Although the take rate (the percentage of billings that Groupon recognizes as revenue) increased for the third straight quarter, billings posted a sequential decline (down 5%) and the active customer count increased just 3% from the first quarter.

Profitability was mixed. Gross margin dropped about two and a half points sequentially. Consolidated segment operating income (or "CSOI"), a weird financial metric that Groupon invented, came in at $72 million and also missed expectations. Although lowering marketing spend ought to have helped margins, the larger contribution of Groupon Goods (with its lower margins) didn't help.

SEE: Understanding The Income Statement

Guidance Calls For More Pain
Investors clearly didn't like what Groupon management had to say about the near future. Calling out badly-chosen deals as a contributor to disappointing international revenue, it looks like marketing expenses will have to head higher again. That is going to lead to some pretty significant (roughly one-third) cuts to CSOI expectations for not only the next couple of quarters, but likely for the out years as well. If nothing else, it seems as though analysts are moving more strongly to a "show me" attitude about this company.

The Need Is There, but What About the Competition and the Model?

I like the basic premise of what Groupon offers - it gives merchants a low-risk, theoretically high-volume means of acquiring new customers. Better still, it's a clearly measurable way of acquiring those customers. I also like the company's strong position in mobile, with roughly one-third of the company's transactions already occurring that way.

But while the service that Groupon offers may be necessary, that doesn't make it easy. Facebook, Yelp (NYSE:YELP), and OpenTable (Nasdaq:OPEN) have already backed away, and bears seem convinced that the market is there for the taking by Google (Nasdaq:GOOG) and Amazon (Nasdaq:AMZN). To that end, decelerating billing and revenue growth and lower margins don't offer a strong counterargument.

There are going to be some familiar bear themes repeated around Groupon. Can the company maintain adequate merchant satisfaction (perhaps already an issue in Europe)? Is the business model sustainable, and/or will the company ever be able to lower its marketing spend and leverage its margins? Will LivingSocial beat them at their own game?

The Bottom Line
I went into this expecting not to like Groupon and to find very little (or nothing) of substance to the model. I was surprised, though, to see just how much skepticism surrounds this name. I can understand the long-term margin worries, and I do share them, but I think the opportunity in customer acquisition is both real and large.

SEE: 5 Must-Have Metrics For Value Investors

You can get a double-digit fair value target on Groupon with a low-teens forward free cash flow growth estimate, which is quite a bit less than investors assume for the much-larger Amazon. There's certainly the risk that competition smothers Groupon's ability to grow its revenue and/or improve its margins, but it's pretty clear to me that today's valuation doesn't assume all that much future success for Groupon and patient bulls may get the last laugh here.

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

Related Articles
  1. Investing

    Time to Bring Active Back into a Portfolio?

    While stocks have rallied since the economic recovery in 2009, many active portfolio managers have struggled to deliver investor returns in excess.
  2. Economics

    Investing Opportunities as Central Banks Diverge

    After the Paris attacks investors are focusing on central bank policy and its potential for divergence: tightened by the Fed while the ECB pursues easing.
  3. Stock Analysis

    The Biggest Risks of Investing in Pfizer Stock

    Learn the biggest potential risks that may affect the price of Pfizer's stock, complete with a fundamental analysis and review of other external factors.
  4. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  5. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  6. Markets

    PEG Ratio Nails Down Value Stocks

    Learn how this simple calculation can help you determine a stock's earnings potential.
  7. Investing

    Playing The Decline of Traditional Broadcast Media

    Broadcast media is losing viewership as cord cutting by the younger generation triggers subscription losses at cable and satellite companies.
  8. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  9. Investing

    What’s the Difference Between Duration & Maturity?

    We look at the meaning of two terms that often get confused, duration and maturity, to set the record straight.
  10. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  1. What does low working capital say about a company's financial prospects?

    When a company has low working capital, it can mean one of two things. In most cases, low working capital means the business ... Read Full Answer >>
  2. Do nonprofit organizations have working capital?

    Nonprofit organizations continuously face debate over how much money they bring in that is kept in reserve. These financial ... Read Full Answer >>
  3. Can a company's working capital turnover ratio be negative?

    A company's working capital turnover ratio can be negative when a company's current liabilities exceed its current assets. ... Read Full Answer >>
  4. Does working capital measure liquidity?

    Working capital is a commonly used metric, not only for a company’s liquidity but also for its operational efficiency and ... Read Full Answer >>
  5. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
  6. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>

You May Also Like

Trading Center