3% Spread As Groupon Trades Below Discounted Value

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Groupon (NYSE:GRPN), launched in October 2008 in Chicago, is a local e-commerce market place. It features daily deals offering goods and services of merchants to customers at a discount. The company is also into online retail business through its arm, Groupon Goods. In 2011 North America consisting of US and Canada accounted for 40% of total revenue while international operations contributed balance 60% of revenue.

INVESTMENT TRIGGERS

The company has significantly expanded its global operations and is having presence in around 48 countries. The share of international operations is continuously increasing. The active customers of company have risen from 15.4 million in January 2011 to 38 million in June 2012. Various acquisitions made by the company in the previous two years are expected to provide diversification to business model; add new customers and reduce marketing costs. The increase in e-commerce spending through mobile phones is expected to benefit the company. Launch of Global Payments service through which merchants running Groupon daily deals can accept credit card payments at a lower rate is also expected to benefit the company.

VALUATION

Our DCF based valuation model provides value of $5.47 for each share of the company.  We have obtained equity value of $3,527 million for the company on the basis of WACC of 9.9% and terminal growth rate of 2%.  Equity value of the company includes DCF stream of $1,005 million; terminal value of $1,207 and financial assets of $51 million less adjustments for net debt and minority interest. WACC has been calculated on the basis of Beta of 1.36; risk-free rate of 1.69% being rate on 10-year US treasury and market risk premium of 6%.

INVESTMENT RISKS

The major business of the company of daily deals has low entry barriers to entry and many new companies with similar business models have emerged across the world and local companies understand the local market well. The competition from big companies like Google and Amazon.com has also increased.   Also the economic slowdown has impacted spending and affected companies in daily deal services. Many such small companies have shut operations in recent period. The European operations of the Groupon Inc. are also struggling. The quarter-on-quarter growth in revenues and active customers is coming down. Material weakness in internal control over financial reporting and resultant restatements of earnings is also a cause of concern.