The Wall Street Journal ran an article July 7 that brings into full view some of the flaws in RetailMeNot’s (SALE) business model. The online coupon business garners 65% of its traffic from search, making it overly dependent on Google’s (GOOG) algorithm, which changed slightly on May 20, sending SALE stock down 18% over the next three days.
While Google’s algorithm is cause for concern, RetailMeNot has other equally serious problems which the Journal makes abundantly clear.
Is it enough to suggest investors dump SALE stock, which today sits barely above its IPO price of $21, despite reaching as high as $48 in early February? And if so, should investors be moving their money into Groupon (GRPN) or some other coupon-related stock instead?
Based on the numbers, you’re probably better off avoiding the whole thing altogether.
RetailMeNot and Google
Searchmetrics analysis suggests RetailMeNot saw its visibility decline by 33% as a result of the latest tweak by GOOG. But it wasn’t the only one. Ebay (EBAY) and IAC Interactive (IACI) are just two of many that saw their visibility drop considerably. However, SALE stock was the only one to experience double-digit declines in its stock price.
The company itself downplayed the matter, suggesting algorithm changes have occurred periodically since it got into the digital coupon market in 2009. Traffic will fluctuate as a result of those changes. It feels it’s too early to assess the impact of Google’s move, and besides, 35% of its traffic is from sources other than search. Nothing to worry about, right?
I worked briefly (for six months) in 2007 for Geosign, an Ontario-based media company that raised $160 million from American Capital (ACAS), to expand its business, which included a keyword arbitrage adplacement service. The only problem: Google figured out that Geosign was gaming its page-ranking system (and making loads of money in the process) and so it specifically changed the algorithm to shut down businesses operating at the fringes. Geosign closed up shop and with it went 230 jobs … including my own.
I’m not suggesting that the latest update was specifically a smack down against firms like RetailMeNot but given Google competes directly with it and other firms such as Expedia (EXPE), Priceline (PCLN) and EBAY, James Brumley was correct to assume it’s not a coincidence. With Google controlling two-thirds of the search engine market in the U.S., it’s a big kick in the gut for SALE.
But that isn’t the only thing holding back SALE stock…
RetailMeNot’s Other Problem
The premise of the Journal’s article is that SALE is getting 5%-6% commissions from retailers for online sales it had little influence over. Research shows that online shoppers checking out will often (50% of the time) head to RetailMeNot when they see a “coupon code” box in order to save a little extra on their purchase. Marketing-attribution tracker Converto suggests coupon sites are responsible for only 2.4% of the actual introductions.
And yet 96% of its $210 million in revenue in 2013 came from this so-called pay-for-performance business model.
Retailers aren’t this stupid. Sure, there is some evidence that coupons reduce shopping cart abandonment but it’s likely a very small number. The bigger that online sales become, the less likely retailers are going to be willing to throw away revenue. Unless RetailMeNot can figure out how to drive meaningful traffic to retailer websites that converts into attributable sales, retailers are going to cut the commissions they pay to coupon sites. Five percent or more for simply getting in the way of a transaction that was already going to happen seems like an awful lot.
Is Groupon Any Better?
Sameet Sinha is an analyst for B. Riley. He believes that GRPN could achieve its revenue and earnings goals for 2014, a prime reason why he’s upped its stock to “buy” from “hold” and has increased its target price from $6 to $9.50. It might be hard to believe, but RetailMeNot is actually far more profitable than GRPN. However, 2014 could be the turning point for the beleaguered coupon site, which has lost 76% of its value since going public in November 2011.
GRPN stock could be a buy given how far it’s fallen, but do you really want to take a chance on a business whose adjusted EBITDA in Q1 2014 was $40 million on revenue of $758 million? At the same time, RetailMeNot’s EBITDA was $21 million on $61 million in revenue. Even if Groupon’s adjusted EBITDA gets to $300 million in 2014, its margin will be no more than 10% on $3 billion in revenue.
Is that the kind of business you want to put your hard-earned money into? I don’t think so. Sinha might ultimately turn out to be right on his call, but it won’t be without a lot of volatility.
RetailMeNot’s financials don’t look too bad at the moment, but that could change in a heartbeat if retailers en masse give up on its digital coupons or Google’s changes the algorithm to permanently reduce its ability to drive traffic to its website. As for Groupon, I’m not sure what to think. Every time it seems to be making progress, something happens to send its business reeling.
Given the uncertainty that lies ahead for both stocks, I’d stay away from both.
As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.