Groupon is no stranger to controversy. Even prior to its IPO, web forums were questioning the effectiveness of the service, and the legitimacy of its business. Its initial filing documents drew heavy scrutiny for the company’s reliance on a nonstandard metric called adjusted consolidated segment operating income (ASCOI) which stripped out Groupon’s steep costs for marketing and acquiring new subscribers.
Nevertheless, on November 4, 2011, Groupon Inc raised $700 million after increasing the size of its offering, becoming the largest IPO by a U.S. Internet company since Google Inc raised $1.7 billion in 2004. Groupon’s lead bankers, Morgan Stanley, Goldman Sachs and Credit Suisse, split about $50 million in fees with CS taking roughly 40% of the pie. Valued at almost $13 billion at $20 per share, above an initial range of $16 to $18, it eventually hit a high of $31 on the first day. Unfortunately for Groupon, its first day high was also its last.
Despite being in its IPO quiet period, the stock didn’t even make it out of the first month without seeing its stock decline 35% over three days. Before the month was over, Groupon was off more than 50% from that intraday high.
Yet by the first part of 2012, the stock had settled out around the offering price of $20 +/-. Goldman and Morgan Stanley’s BUY ratings in December may have helped slightly, but by the time the report was written it was already well off its lows (note that CS didn’t initiate coverage until almost a year after the offering).
Source: http://www.streetinsider.com/rating_history.php?q=GRPN
The optimism didn’t last. By this time a year ago, a series of missed expectations had taken the stock down again including a 17% decline in one day after the management said that it had identified a “material weakness” in its internal controls over financial reporting. The company also revised its fourth-quarter results to show lower revenue and a larger loss, after finding errors in its accounting for customer refunds. May 10, 2012 marked another 50% decline.
Shortly after its new low, Groupon once again rallied back, reporting an 89% rise in first-quarter revenues. Hallelujah! “Deal density” and “take rates” were improving, and the stock rallied to above $15. The euphoria was short lived. Settling out at $12, Groupon was facing a number of new calls of fraudulence by investors, and second quarter numbers released in August were the finishing touches of another 50% decline gapping 27% on that news.
By November, another quarter, another disappointment, and another 50% decline in the stock. Dropping 20% in one day, Groupon breached $3 per share on November 14, 2012.
In the wake of CEO and co-founder Andrew Mason’s firing last month, and another quarter of below consensus revenue and operating income, as well as reduced guidance, the stock dropped 25%. However, it’s rebound was swift. Maybe investors were getting used to disappointment.
It is tough to tell what is ahead for Groupon. Just prior to the announcement, Morgan Stanley’s research analyst noted, “we continue to believe Groupon is a local eCommerce leader. However, we remain on the sidelines as the company experiments with myriad operating levers and strategies. We would become more constructive on the stock if we could better understand Groupon’s ability to integrate the product companies it has acquired…. We maintain our $4 DCF-based fair value, which implies 5x 2014 EBITDA.” At the time, GRPN was slightly under $6 per share.
The wide discrepancy in bull vs. bear valuation rests in MS’ probability that Groupon’s problems are temporary rather than the company not being worth much more than its cash ($2 per share). UBS echoed that analysis, but leaning toward the later with their SELL rating. Yesterday, they called Groupon an “unproven business model.” Unproven? or doomed? The company isn’t a large burner of cash and has no debt. Groupon has generated cash in all of its quarters as a public company. At a floor value of $2 per share, the prospects could be intriguing for a value type investor who believes in the story. It’s easy to equate down drafts as falling knives, but unlike the real life situation, one can never tell if the knife is done falling.
In its short lifespan, Groupon has declined from a 60 trading day high by 50% a total of four times. In most cases, buying those dips would not have been profitable for short term traders, and potentially devastating for long run buyers. Even off its low, Groupon is down over 82% from that first day of trading. Buying each of the 50% drops and holding the stock for 30 days would have resulted in a capital drawdown of approximately 10%. If instead, you were to invest an equal dollar amount in each of those drops, the aggregate return would be closer to a gain of 4%. Holding the stock 90 days has a more varied result. A reinvestment approach would result in a 22% drawdown of capital thanks to large successive losses in the middle two decline periods. An equal dollar investment would leave you modestly in the black.
We have done research on large declines before. We noted that of the 608 companies that declined at least 50% during 2001, only a total of 18% had rebounded to at least their original price by 2005. Similarly, of the 193 U.S. companies that saw at least a 50% price decline in 2011, only 9% had rebounded to their original price a year later. Sounding like a true momentum player, catching a falling knife can cause pain. However, Groupon’s volatility over the last 18 months has piqued our interest to examine 50% price declines on a shorter term trading basis. The consequences were not much better.
We reviewed two strategies, which we will refer to as the Falling Knife Strategy, with the only difference being the holding periods. The Falling Knife strategy looks for stocks that have declined at least 50% since their previous 60-trading day high. It can hold up to 75 positions at any one time. Although there are periods such as 2008 financial crisis and the 1999-2003 internet bubble where the candidate pools averaged higher, primarily there were 15 to 35 names that qualified at any one time. One of the two strategies holds your purchase for the next 90 days. A derivative strategy holds the stock for only the next 30 days. One problem with the later strategy. Since the holding period is shorter, sometimes it buys the stock again and thereby has two consecutive 30 day holding periods. The purchase price had to be at least $2 per share.
Obviously the general direction of the market will heavily influence the returns of a falling knife strategy. However, in all but three years (1993, 2003, 2009), the 90-day holding period underperformed the S&P 500, and often by a wide margin.
Considering the opportunity for a bounce, the 30-day holding period performed marginally better on an absolute basis, but still continuously trailed the S&P.
So far in 2013, Affymax (AFFX), which was purchased in February, leads the losers with more than a 50% decline since its purchase. On the flip side, Repos Therapeutics (RPRX) has generated a 63% gain with its pop at the end of March. However, the average trade was down. Since January 1st, the strategy has placed 26 trades – all but six have been unprofitable.
In 2012, the win/loss ratio was more even. Four names doubled from their low purchase – Bon-ton (BONT), Combimatrix (CMXR), GMX Resources (GMXR) and Sears (S). In the spirit of being careful of falling knives, only Bon-ton has subsequently maintained is higher levels. The others gave it all back and more. Three names in 2012 lost the majority of their value in the 90 days following the 50% decline.
Large declines in stocks are obviously a result of poor performance and investor frustration. Although bounces are common place, a strategy to anticipate a bounce has performed quite poorly. In many cases, a 50% drop is just the beginning of a longer decline. If you try and catch a falling knife, you might get cut.