When the internet was still relatively new, Groupon (GRPN -0.67%) made a huge name for itself offering coupons to restaurants and other attractions. Then, it tried to switch up its business model in what was, with 20/20 hindsight, a terrible decision to sell physical products. Now that the company is going back to the basics, management is telling investors the fourth quarter of 2022 will be a key turning point for the business. But how true is that?
Very different businesses
Groupon's origin story basically boils down to it providing online marketing for local businesses, something that was out of reach for many mom-and-pop operations. Teaming up with Groupon meant local business owners would provide Groupon's customers with a discount to draw in these new patrons. Groupon took a cut of of the promotional sales for providing the platform, while consumers benefited from the discounts. It was a novel idea that combined the savings of bulk purchases with the fast-growing world of e-commerce.
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A decade ago, it was a very popular platform that attracted a huge number of consumers and businesses. But challenges for this operating model eventually became apparent -- businesses started to find that coupon customers weren't necessarily turning into repeat customers, for example. Instead of trying to refine the offering, Groupon chose to shift gears in a massive way and began to offer physical products through Groupon Goods.
Creating a platform for deals is fairly cost effective, since there's no inventory, storage, or delivery costs. Selling physical products is an entirely different business model, one that required Groupon to suddenly compete with giant retailers like Walmart and Amazon. Not surprisingly, that new strategy didn't work out, and Groupon has returned to its roots offering coupons and promotions. The transition has been tough, but nearly three years after exiting that business, management says the company will be cash-flow positive starting in the fourth quarter of this year.
Good, but not enough
If a company is generating positive free cash flow, it can usually limp along even if its business model remains challenged. So this is a very important step for Groupon. But the bigger question for investors is whether or not Groupon's business is one that can stand the test of time. On that score, there are still signs of trouble.
For example, CEO Kedar Deshpande, who is leading the back-to-basics shift, stated in the third-quarter earnings release, "Improving local purchase frequency is the most important measure of how well we are executing our strategy, and we are going to be relentless in driving this metric higher." Sounds great, but the company's success here has been somewhat mixed.
On the international side of the business, which accounted for $36.5 million in revenue, active local customers (for the coupon business) increased 22% year over year in the third quarter. That's good news, but this region only accounts for about a quarter of the company's total revenue. In the much larger North American business, with sales of $107.9 million in the quarter, active local customers decreased 9%.
There are a lot of moving parts here -- revenue was drastically lower in each of the geographic regions because of the switch from selling products to deals. But the metric the CEO highlighted as being "most important" is still showing notable weakness in its biggest market.
Even if Groupon achieves positive free cash flow in the final quarter of 2022, it may not mean much if it can't improve its ability to engage with consumers. Indeed, despite the company's statements about cash flow, if engagement continues to decline in its core market, Groupon may not be able to sustain the positive momentum for that metric.
Still a work in progress
Groupon has been a turnaround stock for much of the past decade. Customer engagement metrics in North America suggest there's still more work to do. Adding to the risk here is the fact Groupon burned through nearly $200 million in cash through the first nine months of 2022, leaving it with around $300 million of cash on its balance sheet.
While there's still potential for a lasting recovery, particularly if the company can sustain its positive free cash flow, Groupon needs to get the "most important" metric heading higher across the company before it can claim success. If there's a recession, which many experts anticipate in the coming year, the turnaround will get even more difficult. Groupon remains most appropriate for investors with a big appetite for risk.
