Photo: Flickr/Hubert Burda Media
Groupon has reported its Q3 results.In a surprise to many sceptics, the company is now operating basically at break-even, a vast improvement over the past several quarters, during which the company has lost boatloads of money.
This should help persuade Groupon’s many sceptics that the company will eventually have a nicely profitable business.
(And the sceptics are mighty confident, by the way. They’re also in the majority. Read this article, “Groupon Is A Disaster,” to get a sense of the current thinking.)
That said, the quarter was not all good news.
The reason Groupon reached break-even is that it cut back sharply on marketing costs. Although the company’s marketing efficiency improved (cost-per-new-customer dropped), Groupon also added fewer customers than it has in prior quarters. This, in turn, led to a slowdown in the company’s revenue growth rate, especially in the North American business.
In other words, as expected, Groupon’s new focus on profitability is leading to a slowdown in the growth of the business. This deceleration will likely persist over the next several quarters, as the company transitions from hyper-growth to profitability.
Importantly, thanks to its excellent cash cycle, Groupon generated $60 million in free cash flow in Q3 and increased its cash balance by $20 million (it spent the rest on acquisitions). This lessens the concern that Groupon will face a cash crunch. If the company’s IPO is successful, the cash concern should disappear, as the company will then have about $750 million on its balance sheet.
After analysing the Q3 results, in other words, our thesis on Groupon remains unchanged:
The company is the global leader in a massive new business opportunity, and it will eventually build a large, profitable business. Groupon is now in a “gangly teenager” phase, however, and the transition from losses to profitability will require it to continue to significantly reduce marketing spending as a per cent of revenue. This will result in a sharp slowing of the company’s revenue growth rate over the next several quarters. (For more, see “THE TRUTH ABOUT GROUPON: Yes, It Can Make Money“)
Even more encouraging: Groupon's North American business is now nicely profitable, earning $19 million in adjusted operating income in Q3, a 12% margin. This bodes well for the company overall.
And now let's look at the main reason for the suddenly improved profitability... A sharp decline in marketing spending.
Marketing spending has dropped sharply as a percentage of revenue for the past two quarters. This has directly improved the bottom line.
But here's the good news... The reason Groupon should be able to build a healthy, growing, and profitable business is that, according to our estimates, its existing customers account for an ever-growing portion of its gross billings and revenue. Here's gross billings. The dark blue is our estimate of billings-from-existing-customers.
And here's revenue. The dark red is our estimate of revenue from existing customers. If Groupon stopped marketing tomorrow, the existing customers would continue to buy stuff. And the company would suddenly be wildly profitable.
Groupon says these new products are the reason for the decline in the take-rate in Q3.
Here's the language from Groupon's latest filing:
We retained less of the gross billings paid by our customers on a percentage basis in the third quarter of 2011 compared with the second quarter of 2011. This was the result of a change in deal mix within the quarter. In the third quarter of 2011, we launched several new channels, including travel (Groupon Getaways), live concerts and events (Groupon Live) and consumer products (Groupon Goods). These new channels had lower deal margins than our standard featured daily deals. Over time, we expect our deal margins in these new channels to improve.
If the declining take-rate is just a mix issue, this is less of a concern, especially if the new products will become more profitable once they mature.