Do ends meet at Groupon?

Do ends meet at Groupon? CEO Andrew Mason is very upbeat in Groupon’s initial public offering prospectus about the future of the company. But is the future as bright as he states? From our point of view there is only one major driver in this business – subscribers! The company needs to stop burning cash – but can Groupon lower its marketing efforts and still grow?

Potential drivers of the business
We identify four potential drivers of Groupon’s business and based on company data question whether they are for real? We use ratio calculations to get a better understanding (see table 1).
First of all we split “Gross Revenue”. Groupon receives 41-43 percent of gross revenue with the remainder going to the merchant. It is difficult to see Groupon expanding its share of gross revenue as competition in the marketplace will probably continue to put pressure on margins. Furthermore it has declined over the past years so we don’t expect a rise from here.

Secondly, Groupon uses a measure “Revenue per subscriber” which indicates the revenue potential of the subscriber base.  This amount per subscriber has been very stable around USD 11.6. We don’t see a driver here given the relatively stable amount of revenue Groupon has been able to extract from a subscriber (see table 1).

Thirdly, conversion from subscriber to customer is another measure, see table 1. This measure has been stable at around 20-21 per cent. If we are to point to any dark horse in this current analysis of Groupon then this is it. Maybe Groupon is able to increase conversion over time, as their business is refined, but with a 20 percent level of churn – see further down in the analysis - the base will have problems in maturing. Essentially the company “starts over and over” with subscribers; therefore we don’t see conversion as the driver.

The fourth and last driver is “growth in subscribers”. This is the main driver Groupon can attack and this is what we analyse in the following section.

Acquisition of subscribers and customers
In the current expansion phase of the company there is a substantial cash drain – even though the company states otherwise. Therefore it is not possible to sustain this elevated marketing spend for much longer.
This is where the contradiction sets in – growth has to come from subscribers but this could also potentially kill the company. Will the company be able to find a compromise where it survives and grows? We have our guesstimates and our opinion on this.

Acquisition cost
In 2010 the average cost of one subscriber was USD 6 and in 2011 (9m) the level increased to USD 6.6, see table 1. The cost rose by 10 per cent in less than a year – and this fact was mentioned by the CEO Andrew Mason and he acknowledges that the easy subscribers are probably already in the subscriber base and the marginal effect of marketing is declining.

Marketing spend
Groupon has spent an enormous amount of money on marketing. In 2010 93 percent of revenue was spent on marketing and for the first nine months of 2011 this declined to 55 percent (see table 1). The reduction is substantial but the company is still cash negative. Groupon has to cut its marketing costs further.
 
We think that Groupon will reach an annual level of USD 190-200m in marketing costs very soon, resulting in a considerable improvement in profitability. Our approach is very simplified as we don’t change the top-line, Selling, General & Administrative (SG&A) etc. But with this in mind - marketing to revenue costs decline to 17.3 percent and Groupon turns to profit with an EBIT margin of 18 per cent.

Our guesstimate of USD 190-200m is based on the assumption that each subscriber costs USD 6 i.e. the 2010 level. Secondly in the prospectus we found that Groupon depreciates a subscriber over 4.5 years i.e. 22 per cent of the subscriber stock unsubscribes each year. This means more than 30m subscribers have to be replaced each year. On top of this Groupon wants to grow its business so additional subscribers have to be acquired. All in all this leads to a total capture of 32.2m subscribers or the equivalent of USD 190m-200m in marketing costs.

Is this a viable business? Does Groupon earn the subscriber capture costs back again and then some? Yes, in this simplified calculation it would take a bit less than three years to earn back the marketing costs (see last row in table 1). This is uplifting as Groupon seems to have room to hit a sweet spot. Whether this is enough to justify the current valuation is up to you.

For more analysis on Groupon see the themes:
Groupon – a scalable business?
Groupon - the client guessing game