Groupon Inc (GRPN)’s Goods Model Not Good For Gross Margins

Groupon Inc (NASDAQ:GRPN)’s Gross Margin would be adversely affected if the company increases its Groupon Goods business. In a report published Monday, Piper Jaffray analysts Gene Munster, Matthew E. Lebo, and Douglas J. Clinton wrote, “we note that if direct revenue (mostly Groupon Goods) were to increase as a percentage of revenue above our model, it would likely have a negative impact on the Street’s Gross margin and EBITDA”.

In the report, the analysts performed a sensitivity analysis on the impact of direct revenue accounting, which showed that adjusted (excluding direct revenue) revenue growth rate for Q3 would have been 12 percent and 35 percent, as compared to the reported growth rates of 35 percent and 45 percent, respectively.

Groupon Inc (GRPN)'s Goods Model Not Good For Gross Margins

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The analysts’ model assumes 2013 gross billings of $5.6B, revenue of $2.7B, and a 65 percent gross margin ($1.77B gross margin), which is in line with the Street. Additionally, the model assumes 85 percent of Gross Billing (72 percent of revenue) is 3rd party (the majority of which is the traditional deals business), with a 40 percent take rate and an 85 percent gross margin. The analysts note that 14 percent of gross billing comes from direct revenue (the majority being Groupon Goods), which have a gross margin of 13.8 percent.

According to the model, 3rd party (3P) products have a higher gross margin compared to Groupon Goods. The analysts note that direct revenue is expected to grow by 95 percent in 2013, as compared to 1800 percent in 2012. Considering the fact that direct revenue products share website space with 3P products, upside to direct revenue, will likely decrease 3P revenue and cause downside to gross margin. The analysts model estimates that 14 percent of gross billing (which is 28 percent of revenue), will come from direct sales in 2013, and would have 14 percent gross margin.

The chart above indicates that while revenue increases when direct revenue is added, the overall gross margin decreases, as from quarter one 2012 reported revenue is above adjusted revenue, whereas adjusted gross margin (which excludes direct revenue) is above reported gross margin.

Increases in Groupon’s direct revenue seems to drag the overall gross margin as exhibited in the chart below. An increases in direct revenues in 1Q12 and 2Q12 resulted in a decline in the overall gross margin respectively. Also, 3rd party revenues declined inversely in relation to the increase in direct revenue.

Groupon Inc (GRPN)'s Goods Model Not Good For Gross Margins

Groupon Inc (NASDAQ:GRPN) shares have dipped more than 80 percent since the company listed at the NASDAQ stock exchange towards the end of 2011; with regard to valuation of the company’s stock, the analysts noted, “we remain neutral on shares of Groupon as we continue to monitor its efforts to build a local commerce ecosystem and turn around international growth”.

Groupon Inc (NASDAQ:GRPN) stock closed at $4.14 per share on Friday.