Author: Barry Randall, Crabtree Asset Management
Covestor model: Crabtree Technology
In the field of comedy, there is something called “a gift.” It’s a person or event that seems to provide an endless stream of material, a mother lode of comedy gold. Like Newt Gingrich. Or Octo-mom. Or Lindsay Lohan.
In the world of investing, Groupon (GRPN) is our gift. From the video of its CEO Andrew Mason doing yoga in his underwear to the company inventing a brand new accounting metric (“Adjusted Consolidated Segment Operating Income”?), Groupon has consistently offered up brightly wrapped nuggets of fun and happiness to the often dry and drab world of business.
And on Friday, March 30, Groupon gift-wrapped yet another box of joy, a restatement of their financial performance in their fourth quarter, which ended three full months ago, and which was originally reported in mid-February. The specifics are pretty dry, but the bottom line is that, a) the company should have accounted for a higher level of refunds; b) revenue was therefore lower; c) the reported net loss was therefore larger and d) the whole mess shows their internal accounting controls are (still) lacking. That they released this information late on a Friday, after the market close, was the equivalent of a flashing “APPLAUSE” sign in the sky.
The really funny thing is, however, that such shenanigans aren’t really Groupon’s biggest weakness. We’ll get to that, but not before acknowledging the company’s status as the undisputed king of the Daily Deal marketing segment. Groupon’s market share is twice that of its nearest rival, LivingSocial. And it has a vast number of “subscribers,” to whom it sends deep-discount coupons on behalf of merchants looking to drive traffic and repeat business.
Merchants remain attracted to Groupon because they (e.g., restaurants, hair salons, skateboard parks) don’t have the marketing resources to run such promotions. Moreover, because Groupon charges only for a percentage of the deal, the deal is only a variable, rather than a fixed cost. If it works, great, but if it doesn’t, the merchant isn’t incurring any ongoing expense of an ineffective marketing department.
A Groupon “subscriber” is merely someone who’s added their email to Groupon’s mailing list. And as of the end of December, Groupon claimed to have 170 million such subscribers. This immense number is the carrot that Groupon dangles in front of merchants, many of which only haphazardly collect and utilize email and contact information from their own customers.
But really, how valuable is Groupon’s subscriber list? Since they spent over $400 million to acquire all those email addresses, I guess you could say they’re pretty valuable. But I’m being sarcastic because, really, who wouldn’t sign up (for free) with Groupon to receive 50% off of almost anything? That’s like asking people if they’re in favor of world peace. Who would say no to that?
The real lever on whether daily deal coupons work is whether they work for the merchants offering them. Yes, Groupon’s “subscribers” pay for the Groupons, but that is just an up-front subsidy by the merchant offering the product or service, who will be paying full-price cash to provide the product or service they’ve just offered at (effectively) about 75% off list price.
Without merchants to offer them, Groupon and all the daily deal enablers have no business. And overall, merchants aren’t uniformly thrilled with deep discount daily deals. Survey results vary, but in the aggregate (and avoiding Groupon’s own surveys) about 50% of merchants who have done a daily deal elect not to do another. The choice of whether the merchant does another is dependent upon the usual advertising calculus: is the up-front cost repaid in long-term customer profit?
Enter Constant Contact (CTCT), better known to most of us for the logo you see at the bottom of church group or PTA newsletters. Just as Groupon dominates daily deals, Constant Contact similarly rules email marketing, with more than 500,000 paying customers, a large fraction of which are small businesses. And now Constant Contact has cracked the code on daily deals, with a new service called SaveLocal , announced in late February and is already in limited release.
Basically, SaveLocal inverts the power dynamics of the daily deal, by putting the merchant in charge of the process in the following ways:
- The merchant markets the deal to their own email list, rather than broadcasting through the bullhorn of Groupon.
- The merchant can choose the amount of the discount, rather than being forced to choose Groupon’s standard 50% off.
- The merchant doesn’t have to pay Groupon half of the coupon value, but instead chooses a fixed rate of $1, $2 or $3 per coupon.
(These latter two factors are key because it allows the merchant to fine-tune the deal for profit, both in the short-term – the actual deal and the redemption of coupons – and the long-term – what is the repeat business rate of new, non-discounted business?)
- The merchant can offer the potential customer additional discounts, if they pass along the coupon to others in their social network, and then capture that new customer’s email address, adding them to the merchant’s list.
It was inevitable that some vendor was going to put the power in the hands of the merchants, who really should have had it all along. And it’s also inevitable that SaveLocal features will be copied by other marketing services vendors, perhaps even by Groupon itself, which is why this doesn’t necessarily make Constant Contact a screaming buy.
But Constant Contact should certainly have the stage to itself for a few months, as merchants interested in daily deals (but unwilling to pay tribute to Groupon) finally have a savior.
A lot of people think that email marketing is doomed because email is doomed. Too many people are tweeting or texting each other now, or posting updates to Facebook. But size limitations of the former, and privacy issues related to the latter still leave plenty of room for POEMs (“Plain Old EMails”).
So what’s the trade here? Easy: Constant Contact has empowered merchants in a way that Groupon hasn’t, and probably never will. Constant Contact is consistently profitable, has 20% operating cash flow margins, rising ARPUs, a predictable SaaS-based subscription business model, and a recent history of exceeding quarterly earnings estimates. It has a market cap of $880 million.
The only one of those attributes Groupon has is a market cap. It’s $9.5 billion.
I’m sorry, but did somebody say, “pair trade?”
Thank you! I’ll be here all week.