Why Groupon is Falling

Shares of daily deals site Groupon, Inc. (NASDAQ:GRPN) fell 15.5 percent, or $3.11, Wednesday to $16.96, more than $3 below its initial trading price of $20.

Shares of Groupon have been falling for the past three days. The shares closed at $23.58 Nov.21, $20.07 Nov.22 and $16.96 Nov. 23. All these three trading days saw whooping volumes as 2.6 million shares of Groupon were traded Nov.21; 5.22 million shares traded Nov.22, while Nov. 23 saw trading of 7.89 million shares.

Groupon shares started trading at $20 Nov.24 on Nasdaq after it raised $700 million in its initial public offering, making it the biggest IPO by a U.S. Internet company since Google Inc raised $1.7 billion in 2004.

We are not surprised to see volatility in Groupon given it is highly controversial, somewhat unproven, early in its development cycle and has a subjective valuation do to a lack of cash flow or earnings. We suspect stock market sentiment will play a large part in short-term swings in Groupon's stock, Benchmark Capital analyst Frederick Moran wrote in a note to clients.

Some conjecture as to why Groupon has traded down includes:

* Renewed fears of European economic slowdown or possible recession could hinder Groupon's growth given that Groupon derives 60 percent of its revenue from outside of the US, mostly Europe.

* Closest competitor, LivingSocial, is raising capital and making a holiday push showing competition remains intense.

* eCommerce holiday sales, especially vouchers, could disappoint.

* The cost of borrowing the stock to short sell has lessened.

* The broader stock market and leading Internet stocks have weakened.

Moran, who has a buy rating on the stock, said he did not believe much has actually changed since the IPO of Groupon.

We view the European economic uncertainty as the biggest overhang on the shares of Groupon as well as some of our other Internet stocks like Amazon (NASDAQ:AMZN), Google (NASDAQ:GOOG) and Priceline (NASDAQ:PCLN) because they all have substantial exposure to Europe and are cyclical businesses. If the global economy goes into recession most eCommerce stocks are at risk of underperforming, said Moran.

Competition in the daily deals space is intense and LivingSocial represent a tough #2 competitor. But, LivingSocial's holiday national deals will not out do those from Groupon. Groupon has been and likely will continue to gain market share. Groupon's US market share in September stood at 54 percent versus Living Social at 22 percent.

Meanwhile, comScore and other eCommerce tracking services are predicting a robust eCommerce holiday with continued market share gains from traditional retail leading to mid-teens growth from last year.

US eCommerce sale in October jumped a whopping 16 percent representing the fastest growing month of the year according to comScore. Even retail has held up growing 7 percent growth in October. There is absolutely no sign of eCommerce slowdown in the US yet.

Vouchers, daily deals and discounting are not the most discretionary of eCommerce purchases. Consumers are looking for deals from local merchants and Groupon enables them to find values. Groupon could get a boost from holiday buying as consumers use it as a gift giving tool.

Moran said Groupon could experience exponential growth and potentially high profit creation. Groupon's roughly breakeven EBITDA and operating income in the third quarter shows its potential for profitability depending on marketing expense spending levels.

We expect instant mobile offerings from Groupon Now, plus ongoing diversification of offerings including travel via Groupon Getaways and product deals, to combine with geographic expansion to drive total Groupon gross billings growth of 450% y/y in 2011 to $4.1 billion, leading to $1.6 billion of revenue. We project revenue could grow 56% to $2.5 billion in 2012 and 23% to $3.1 billion in 2013, said the analyst.

Groupon has created a new Internet platform for local commerce which stimulates consumer spending that may not otherwise occur. It uses pricing discovery to create supply and demand. Groupon's 190,000 featured merchants and 143 million subscribers provide unmatched reach. Discount offerings via email reach millions of consumers each day. Groupon can deliver thousands of new customers to a merchant through a single promotion.

Groupon trades at 4x 2012E revenue of $2.5 billion, down from 6x at the close of its first trading day and 5x at its $20 IPO price.

Groupon stands well-positioned for exponential growth related to building consumer interest in Daily Deals. Barring a global recession we think Groupon will show impressive growth over the next few quarters that could drive the stock, said Moran who has a $32 price target on the stock.