It seems that Google is poised to make a potential $6 billion acquisition of Groupon which has been described as $5.3 billion in upfront consideration and $700 million in performance awards for management. Investor reaction yesterday was negative with the stock falling 4.5% and the internet appears to be on fire with bloggers and journalists bashing Google’s reckless spending. Afterall, $6 billion is double the value Google paid for Doubleclick. It’s $2 billion more than current rumored valuations for Twitter! Such an inflated purchase price for Groupon must surely be a sign that Google just doesn’t know what to do with its cash hoard, right? Well, before making wild declarations, let’s try to put pen to paper and figure it out.
Valuation
Let’s start by throw out the Twitter and Facebook valuation comparisons. Facebook recently reached valuations between $33 billion and $50 billion on Second Market. Various online sources appear to pin Facebook’s revenues anywhere from $1.2 billion to $2.0 billion in 2010. The Company only became cash flow positive in Q2 2009. Even by the loftiest of expectations, Facebook is trading between 16x and 25x revenue likely near 100x cash flow earnings. Twitter did not announce a monetization strategy until April of this year and was projecting just $140 million in 2010 revenue in 2009. If they hit their projection, this would equate to 28x revenue. But, let’s be honest, Groupon is a vastly different business than Facebook and Twitter so let’s literally “throw out” these valuations (for now).
To me, Groupon is best compared to an internet retailer. By way of precedent transaction, Zappos was purchased for $1.2 billion by Amazon in 2009 which was essentially a 1.2x revenue multiple. However, Zappos was well known to run razor thin margins, rumored to be well in the single-digits. If this is true, then Zappos likely changed hands at well over a 30x EV/EBITDA multiple.
Comparing to larger, more mature e-tailers, Amazon trades at 2.6x revenue and 39.7x EV/EBITDA. EBay trades at 4.2x revenue and 11.8x EV/EBITDA.* The disparity in these metrics likely lies in the fact that E-Bay runs high-teens operating margins and Amazon runs low-single digit margins, but Amazon has been growing revenues at over 30% year-over-year while E-Bay has seemingly hit a growth wall over the last few years.
So, what does this all mean to Groupon? Consensus seems to be that Groupon will have sales around $500 million this year. However, it has grown dramatically month-over-month and could be selling at a run-rate in excess of an annualized $600 million in gross sales. Assuming Groupon typically takes 50% of gross sales as its cut and then must pay overhead. Groupon’s overhead cost structure is likely to be significantly better than that of most tech companies with less of demand for hardware and most of its costs in personnel as the site doesn’t have to do any more than handle requests one deal at a time (no videos, photos, messages, etc.). It’s not hard to imagine that Groupon’s EBITDA margins are closer to that of an EBay, and possibly better. Let’s assume they are 25%. Additionally, relative to the tech startups and tech-heavy retailers I’ve described above, Groupon’s business model is likely working capital negative and lower capital intensity which would mean that Groupon’s EBITDA quality (as a proxy for cash flow) is likely higher than the others above.
Given these qualities of the Groupon business, it would seem fair that Groupon would deserve an EV/EBITDA valuation at the high end of the range for retailers. Groupon is a younger company than Amazon, but has a business model which is fundamentally more limited, so I’ll split the difference and apply the exact same multiple (39.7x). So, how much is Groupon worth? $600 million x 25% x 39.7 = $6.0 billion. Well, suddenly I feel a little better about Google’s valuation. Do you?
* I acknowledge that I’ve mixed enterprise value and equity value metrics, but Groupon is likely a debt-free startup, I’m taking the liberty of assuming enterprise value and equity value are close.
Considerations/Risks to the Valuation
Clearly, Google is paying a full price. Moreover, depending on which metric drive’s Google’s public valuation, this deal may prove to not be value accretive. Google is currently trading at 6.5x revenue but just 13.0x EV/EBITDA. Accretion/dilution aside, on a standalone basis, I wouldn’t call Amazon’s stock cheap and Groupon has some obvious limitations to its appeal and value proposition which could limit its trajectory.
Additionally, the above analysis is clearly based on some aggressive assumptions. Even assuming that some of them are accurate today, there are serious questions about whether Groupon can sustain high-levels of profitability given increasing competition and some criticisms by partners over the sustainability of offering 75%-90% discounts.
All this said, Google is not buying Groupon as a standalone business and a significant case could be made for valuation upside due to Groupon’s strategic value. Ostensibly, Google believes that it can integrate Groupon as part of a broader customer experience platform and enable various other parts of its service offering – particularly in local advertising. If this is true, could it be possible that Groupon can create value within Google more similar to the stratospheric valuations that Facebook and Twitter and other “true web” startups garner?
Full disclosure: Author is long shares of GOOG at the time of writing.
Dang Hung
http://thecuriousinvestor.com/
Valuation
Let’s start by throw out the Twitter and Facebook valuation comparisons. Facebook recently reached valuations between $33 billion and $50 billion on Second Market. Various online sources appear to pin Facebook’s revenues anywhere from $1.2 billion to $2.0 billion in 2010. The Company only became cash flow positive in Q2 2009. Even by the loftiest of expectations, Facebook is trading between 16x and 25x revenue likely near 100x cash flow earnings. Twitter did not announce a monetization strategy until April of this year and was projecting just $140 million in 2010 revenue in 2009. If they hit their projection, this would equate to 28x revenue. But, let’s be honest, Groupon is a vastly different business than Facebook and Twitter so let’s literally “throw out” these valuations (for now).
To me, Groupon is best compared to an internet retailer. By way of precedent transaction, Zappos was purchased for $1.2 billion by Amazon in 2009 which was essentially a 1.2x revenue multiple. However, Zappos was well known to run razor thin margins, rumored to be well in the single-digits. If this is true, then Zappos likely changed hands at well over a 30x EV/EBITDA multiple.
Comparing to larger, more mature e-tailers, Amazon trades at 2.6x revenue and 39.7x EV/EBITDA. EBay trades at 4.2x revenue and 11.8x EV/EBITDA.* The disparity in these metrics likely lies in the fact that E-Bay runs high-teens operating margins and Amazon runs low-single digit margins, but Amazon has been growing revenues at over 30% year-over-year while E-Bay has seemingly hit a growth wall over the last few years.
So, what does this all mean to Groupon? Consensus seems to be that Groupon will have sales around $500 million this year. However, it has grown dramatically month-over-month and could be selling at a run-rate in excess of an annualized $600 million in gross sales. Assuming Groupon typically takes 50% of gross sales as its cut and then must pay overhead. Groupon’s overhead cost structure is likely to be significantly better than that of most tech companies with less of demand for hardware and most of its costs in personnel as the site doesn’t have to do any more than handle requests one deal at a time (no videos, photos, messages, etc.). It’s not hard to imagine that Groupon’s EBITDA margins are closer to that of an EBay, and possibly better. Let’s assume they are 25%. Additionally, relative to the tech startups and tech-heavy retailers I’ve described above, Groupon’s business model is likely working capital negative and lower capital intensity which would mean that Groupon’s EBITDA quality (as a proxy for cash flow) is likely higher than the others above.
Given these qualities of the Groupon business, it would seem fair that Groupon would deserve an EV/EBITDA valuation at the high end of the range for retailers. Groupon is a younger company than Amazon, but has a business model which is fundamentally more limited, so I’ll split the difference and apply the exact same multiple (39.7x). So, how much is Groupon worth? $600 million x 25% x 39.7 = $6.0 billion. Well, suddenly I feel a little better about Google’s valuation. Do you?
* I acknowledge that I’ve mixed enterprise value and equity value metrics, but Groupon is likely a debt-free startup, I’m taking the liberty of assuming enterprise value and equity value are close.
Considerations/Risks to the Valuation
Clearly, Google is paying a full price. Moreover, depending on which metric drive’s Google’s public valuation, this deal may prove to not be value accretive. Google is currently trading at 6.5x revenue but just 13.0x EV/EBITDA. Accretion/dilution aside, on a standalone basis, I wouldn’t call Amazon’s stock cheap and Groupon has some obvious limitations to its appeal and value proposition which could limit its trajectory.
Additionally, the above analysis is clearly based on some aggressive assumptions. Even assuming that some of them are accurate today, there are serious questions about whether Groupon can sustain high-levels of profitability given increasing competition and some criticisms by partners over the sustainability of offering 75%-90% discounts.
All this said, Google is not buying Groupon as a standalone business and a significant case could be made for valuation upside due to Groupon’s strategic value. Ostensibly, Google believes that it can integrate Groupon as part of a broader customer experience platform and enable various other parts of its service offering – particularly in local advertising. If this is true, could it be possible that Groupon can create value within Google more similar to the stratospheric valuations that Facebook and Twitter and other “true web” startups garner?
Full disclosure: Author is long shares of GOOG at the time of writing.
Dang Hung
http://thecuriousinvestor.com/
