Saturday, December 4, 2010

Barron's on Google's acquisition try of Groupon

"Pass the Groupon, please!"
Rumors circulated on Monday that the company was in talks to pay up to $6 billion in cash to purchase Groupon, a venture-backed company based in Chicago that distributes coupons via the Internet.

Groupon has a novel twist: It extracts deep discounts of as much as 50% from major retailers such as The Gap (GPS) in return for promising to deliver a minimum number of customers. It then engages Web surfers in a game of sorts, telling them they must get as many fellow bargain hunters as possible to respond by a deadline in order for everyone to get the discount. Groupon gets half the sales dollars, and the client gets to market its wares in a whole new way, while paying very little money up front.

The idea that Google, which dominates online advertising, would shell out such a fantastic sum for a two-year-old start-up peddling what amounts to a new form of direct marketing, made some people apoplectic.

Former Fortune magazine columnist David Kirkpatrick asked whether Google (ticker: (GOOG) might be suffering a crisis of confidence. "Groupon isn't even a technology company, for goodness' sake," wrote Kirkpatrick in The Daily Beast. "It's a discounter that happens to use the Internet."

Plenty of reasonable explanations were proffered by the Street. Google is the company best suited to leverage Groupon's 3,000-person local salesforce, Oppenheimer & Co. analyst Jason Helfstein opined. Google can drive traffic to Groupon's deals, while also cutting the administrative overhead for those salespeople, making it more profitable.

And then, too, Groupon has built the brand for this kind of thing, and that's hard to duplicate. The deal would be about six times projected revenue, which is not seen as too rich in the world of technology.

By Thursday, no explanation was needed, for it seemed that suddenly everyone and his brother was doing a deal in the newly minted "local commerce" market.

First, eBay (EBAY) announced that it is acquiring social shopping site, for an amount rumored to be $75 million. Later, (AMZN) said that it made a $175 million investment in Groupon competitor LivingSocial.

And why not? Last Monday, now dubbed "Cyber Monday," was the first billion-dollar day in e-commerce history, according to comScore (SCOR). Much of that was driven by price chopping, and much of it was coming at the expense of traditional retailers. As Youssef Squali with Jefferies & Co. wrote in a research report, "U.S. online sales were up 15.9%, year over year, for Black Friday [...] This is in stark contrast to the 0.3% increase in overall retail sales."

The traditional Black Friday shopping event lost some of its luster as stores including Wal-Mart (WMT) stayed open on Thanksgiving. Welcome to the QVC world of 24/7 shopping.

In a consumer-driven world, something like Groupon that can move goods in a novel way, while restoring some hope to traditional retailers, makes people sit up and take notice, and maybe even write a big check.

Although Groupon is labeled as a social, local revolution, there's nothing remotely social about mobbing coupon offers. And in recent weeks, Groupon has been doing more deals with large national brands, such as Nordstrom, rather than with local mom-and-pop merchants and eateries.

The best explanation for Groupon being the belle of the ball is that we're in Google Land, and that Google can do such a deal simply because it has the money. In this year's first nine months, its cash and equivalents and marketable securities rose 36%, or $9 billion, bringing its total stash to $33.4 billion. And Google throws off about $2 billion in free cash flow every three months.

Groupon is on pace to reach its first billion dollars in revenue in a little over two years—at least, that's the chatter in Silicon Valley. A report this week by Jason Maynard of Wells Fargo estimates more like $600 million in 2011. And Google can afford to pay up for growth. What Google can't, or won't, do, is miss the party in connecting online ads with real-world commerce, the way it missed the boat with social networking.

As I said, fans of Google find it hard to swallow all that. But Needham & Co. analyst Mark May offers some positive thinking. In his view, Google has done well with big acquisitions. It paid $1.65 billion in 2006 for YouTube, which has finally become a billion-buck revenue generator.

Google could pump Groupon's deals in ads carried by the rising number of cellphones running Google's Android software. As Groupon refines the way it profiles each consumer—by gender, buying habits, location and so forth—it can become more astute in funneling the right deals to the right people.

Of course, there's a real danger of diminishing returns. What works for Groupon at a billion in revenue may not necessarily work at $10 billion. There's no knowing how this thing will scale. But that's just the price of an education in Google Land.

At 17 times 2011's estimated earnings per share, with an expected growth rate of roughly 17 times as well, Google stock has a PEG ratio (price/earnings ratio to growth rate) of 1.0, which is reasonable. That means that it's not overpriced on a valuation basis, even if what it's doing strikes some investors as unreasonable.

IF IT TURNS OUT GOOGLE'S made an awful mistake, or if it takes a long time to get a return on Groupon, well, in that respect, Google would be in good company. Moody's Investor Services last week examined software mergers and acquisitions over the past decade. Moody's finds that, while deals can have long-term strategic benefits, in the near term most companies don't earn a very good return on assets when they buy other companies.

But rich tech companies such as Google needn't worry about such things. They are flush with cash and minting more all the time. Why not use some of that $33.4 billion to pay a dividend? Well, maybe, someday. But not today, not while there are Groupons to chase.

In any event--the deal with Google is reportedly now toast. We'll see what happens to GOOG on Monday.


db said...

pass the Groupon please .......

Palmoni said...

that was good! I used that!