Why Groupon's Turnaround Plans Will Be a Great Deal for Investors

NEW YORK (TheStreet) -- Shares of consumer deals giant Groupon  (GRPN) have been under pressure for most of 2014. The company reports earnings Tuesday. The stock, at around $7, is down 41% for the year to date.

The way I see it, investors have gotten a raw deal. It's not that Groupon has done anything wrong but Wall Street can't make up its mind what it wants management to do.

Investors, don't be discouraged. Now is the time to buy a company that is on the cusp of a major transformation. In a couple of quarters, analysts will have no choice but to raise their estimates and price targets. In the meantime, the stock, which is trading at just 25 time 2015 estimates, is cheap.

When you match Groupon's growth forecast with that of other Internet/retail names like Amazon  (AMZN) (P/E/ of 157) and Facebook  (FB) (P/E of 35), you can see that Groupon is trading at a meaningful discount to its peers.

From my vantage point, there is at least 40% upside in shares of Groupon in the next six to 12 months. During that span the stock should reach $9 on the basis of margin expansion, cost-reduction and free cash flow growth.

Analyst Sameet Sinha at B. Riley, who has a price target of $9.50 agrees. Sinha recently upgraded Groupon shares to buy from neutral. But the rest of Wall Street is not buying into management's plans to remake the company. Edward Woo of Ascendiant Capital Markets, who has a $5 price target on the stock, was bearishly blunt, saying: "We are not yet convinced that Groupon is on a consistent path towards growth and profitability and believe its share price is likely to remain volatile and weak until it demonstrates it can grow both consistently."

Ahead of Tuesday's second-quarter report, Woo predicts that Groupon will offer weak third-quarter guidance. But that doesn't really matter. 

First, consider that this is a company that is still growing revenue at a 26% rate and profits, which some analyst have never expected, have advanced at modest 2% year over year.

Second, management has begun to invest in a new platform that allows merchants to offer deals while bypassing its salespeople. Groupon wants to, as management calls it, "pull" in its customers. The company seems no longer interested in just pushing out deals that may or may not spark interest. Unlike when ousted CEO Andrew Mason was at the helm, Groupon wants to create its own market instead of operating within one.

This is one way Groupon can significantly reduce its costs and bring efficiency to its model. To the extent that this platform can work, Groupon will be able to reduce both its sales force and capital spending. In the process, this will boost the company's bottom line.

Last but not least, Groupon continues to strengthen its gross billings, which were up almost 30% in the most recent quarter. Gross billings is the metric that reflect the total dollar value of customer purchases of goods and services, excluding applicable taxes and net of estimated refunds. This should dispel fears about competitive threats from Google  (GOOGL) and Yahoo! (YHOO). 

Tuesday, investors will want confirmation that things are going according to plan. Arvind Bhatia of Sterne Agee, who has a $12 price target on the stock, believes investors should focus on three primary areas: the company's international expansion plans, gross margins and revenue growth in local deals.

This means as long as Groupon continues to move in these directions without any hiccups with revenue, investors will do well.

In the meantime, investors must trust management to use capital intelligently. The team is working to develop strategies to turn this company into a long-term sustainable business. It's going to cost money, and it's not going to happen overnight.

Groupon is approaching a period of easier year-over-year comparisons, which means the company should beat its metrics for this quarter and next. Accordingly, I would be a buyer here ahead of Tuesday's results and hold for the long term.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

Follow @Richard_WSPB

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

TheStreet Ratings team rates GROUPON INC as a Sell with a ratings score of D. TheStreet Ratings Team has this to say about their recommendation:

"We rate GROUPON INC (GRPN) a SELL. This is driven by multiple weaknesses, which we believe should have a greater impact than any strengths, and could make it more difficult for investors to achieve positive results compared to most of the stocks we cover. The company's weaknesses can be seen in multiple areas, such as its deteriorating net income, disappointing return on equity, weak operating cash flow, generally disappointing historical performance in the stock itself and feeble growth in its earnings per share."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The company, on the basis of change in net income from the same quarter one year ago, has significantly underperformed when compared to that of the S&P 500 and the Internet & Catalog Retail industry. The net income has significantly decreased by 846.8% when compared to the same quarter one year ago, falling from -$3.99 million to -$37.80 million.
  • Current return on equity is lower than its ROE from the same quarter one year prior. This is a clear sign of weakness within the company. Compared to other companies in the Internet & Catalog Retail industry and the overall market, GROUPON INC's return on equity significantly trails that of both the industry average and the S&P 500.
  • Net operating cash flow has significantly decreased to -$20.72 million or 336.49% when compared to the same quarter last year. In addition, when comparing to the industry average, the firm's growth rate is much lower.
  • Despite any intermediate fluctuations, we have only bad news to report on this stock's performance over the last year: it has tumbled by 26.94%, worse than the S&P 500's performance. Consistent with the plunge in the stock price, the company's earnings per share are down 500.00% compared to the year-earlier quarter. Naturally, the overall market trend is bound to be a significant factor. However, in one sense, the stock's sharp decline last year is a positive for future investors, making it cheaper (in proportion to its earnings over the past year) than most other stocks in its industry. But due to other concerns, we feel the stock is still not a good buy right now.
  • GROUPON INC has experienced a steep decline in earnings per share in the most recent quarter in comparison to its performance from the same quarter a year ago. The company has reported a trend of declining earnings per share over the past year. However, the consensus estimate suggests that this trend should reverse in the coming year. During the past fiscal year, GROUPON INC reported poor results of -$0.14 versus -$0.10 in the prior year. This year, the market expects an improvement in earnings ($0.11 versus -$0.14).

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