Groupon Basks in Morgan Stanley’s Praise

Morgan Stanley upgraded Groupon to “overweight” from “equal weight” causing the daily deal company’s stock shares to jump by as much as 13 percent.

The reason for Morgan Stanley’s apparent change of heart is a shift in the competitive landscape. Daily deal clones are still coming to market, but there is no evidence they are gaining any significant traction, according to a client note written by Morgan Stanley analyst Scott Devitt. Even the biggest competitors — LivingSocial, AmazonLocal and Google Offers — have not gained meaningful traction, or for that matter, developed new innovations to give themselves a boost above Groupon.

At the same time, Groupon is doing better at some key activities, Morgan Stanley said. It is customizing and targeting deals better, which is giving its revenues a boost.

Also, Groupon has trimmed its marketing expenses by 50 percent, compared with the same period last year, Morgan Stanley noted. These improvements should scale to Groupon’s international footprint, continuing to drive revenues.

A Pleasant Surprise

The upgrade must have been very welcome positive reinforcement for Groupon, which has been the tech market’s favorite whipping boy since its IPO road show, when some of its early accounting metrics became a laughing stock.

However, the site has been plugging away making improvements in its processes and services, as Morgan Stanley noted.

Earlier this year, in fact, the company delivered a pleasant surprise to shareholders with its Q1 earnings. Groupon posted stronger-than-expected revenues of US$559.3 million — an 89 percent increase from the same period a year ago.

As part of its earnings report, Groupon also provided research it commissioned from Foresee to assess merchant and customer satisfaction with its model and services. Foresee concluded that Groupon was within two points of the five-year No. 1 average customer satisfaction score for online retailers. Its merchant satisfaction score was 79, higher than the B2B benchmark of 64 and the Fortune 500 score of 69.

Groupon and Morgan Stanley did not respond to our requests to comment for this story.

Less Profit, More Work

For all the progress the site has made — and despite the upgrade from Morgan Stanley — Groupon still faces an uphill road due to a factor that is also recognized in the Morgan Stanley report: the ever-present competition.

“Groupon certainly has weathered extraordinary competition that entered the daily deal space after it made its first mark,” Harlan Platt, professor of finance at Northeastern University’s College of Business Administration, told the E-Commerce Times.

Despite the best efforts of Google Offers, LivingSocial and others, he said, “somehow Groupon has managed to differentiate itself enough so that when consumers think ‘daily deal,’ they first think of Groupon.”

That is the main reason for Morgan Stanley’s upgrade, suggested Platt.

That said, Groupon will never be as profitable or financially successful as its very early supporters assumed it would be, he continued. “It has become clear that the daily deal model is not one that can scale easily or without investing significant costs.”

To continue to grow, Groupon will have to continue to flood markets with thousands of salespeople, he said. Nor can Groupon make up for these costs by edging up its margins, because a merchant can easily go to a lower-cost competitor.

“That right there tells us a lot about its ability to deliver long-term profits,” Platt said. “What Morgan Stanley has recognized is that Groupon, despite the competition’s best efforts to dislodge it, will remain the pre-eminent seller of daily deals. My caution to investors is that its profits will always remain limited.”

Not a Sustainable Business Model

Some don’t even go that far in their praise of Groupon. The daily deal industry in general is “not attractive” and ultimately “may not be sustainable in the long run,” Peter Cohan of Peter Cohan & Associates, told the E-Commerce Times.

“The basic business model means that as a company gets bigger it has to spend more and more money. It is a dis-economy-of-scale model,” he explained.

Another fundamental problem, is that Groupon and its competitors don’t add value for its merchant base, Cohan said.

“The model is based on people flocking to a restaurant, for example, for the one-time deal. The restaurant, if it is not very careful, probably loses money,” he observed. “And it is still not clear whether the Groupon coupon users become repeat customers in great enough numbers to make a difference.”