Investors owe Barlcays equity research a big thank you. Today Barclays has downgraded Groupon Inc (NASDAQ:GRPN) from overweight to underweight.
The price target was dropped by 73%, from $15 a share to a target price of $4. The only problem? Groupon Inc (NASDAQ:GRPN) closed yesterday at $4.65, so this does not help investors much. They would have been better off reading our research on the day of the IPO titled, Groupon=$20B of Snakeoil. The stock is down 82% since its IPO in November 2011.
Anyway, let us look at how they come to the $4 valuation.
First a quote from Barclays summary (emphasis ours):
Upon further due diligence since the report, and considering that Groupon’s business model could be undergoing a meaningful transition that persists and creates uncertainty, we’re now taking a more pragmatic approach to our forecasts (e.g., CY13 EBITDA to $171mn from $417mn). Based on these new estimates, our target goes to $4 and we are downgrading our rating to Underweight.
We wish that the due dillegence had been done earlier. That would make sense wouldn’t it? The pragmatic/conservative approach also would have been nice slightly earlier. EBITDA forecasts were lowered by 59%, that is a massive revission. Again, it comes to late for the investors who bought at $15, thinking it was an ‘overweight’ stock, Wall Street Jargon for a buy.
However, we feel little pity for these investors as well. Unlike frauds, like Ponzi schemes, or Knight Capital which nearly collapsed due to an error one day, Groupon Inc (NASDAQ:GRPN) always had many warning signs. Even now according to Barclays, Groupon is trading at a price earnings ratio of $99 for this fiscal year.
In Barclays defense, the company does note the change in the business model;
The mix of billings from the sale of Goods (vs. core Local Deals) has risen from near nothing six months ago, to 13% in 2Q 2012 and, importantly, represented the vast majority of incremental growth in 2Q.
The sale of goods have gross margins one third of Local deals. Barclays notes that the advertising expenses for sales of goods are higher and could lead to increased costs. We think that Groupon declined due to other issues, however. Overvaluation, issues with competitors, accounting .
Slightly more on valuation:
Valuation: Groupon’s current EV is $2.5bn, and the company ended 2Q12 with ~$1.2bn
or $1.79/share in cash (and generated $49mn in FCF in the quarter) but also with
$544mn in merchant payables. Our 12-month target of $4 implies a 10x EV/CY13
adjusted EBITDA multiple and a CY13 FCF yield of 7%, and it considers the company’s
slowing growth and the changes in its business model that create uncertainty.
I like to say about sell side reports, that the forecasts are awful but the research is superb. Since my analyst days, when my boss forced me to, I have always gained from reading reports, improving my modeling skills, and learning information about the company, before digging through 10Qs. But as always we warn investors to proceed with caution.
As we noted yesterday, Groupoun might actually be attractive at this point. The market cap of $3 billion is half of what Google offered to buyout the company only a short time ago. We never make recommendations, but we think that the company has many issues, a moat which can only be penetrated by someone with an 8th grade education and a $250 net-book, so we have no idea where the stock will go. However, on valuation alone the company is far more attractive than it was at $15 a share.
Disclosure: No positions in any companies mentioned