3 Questions for Groupon's New CEO

Struggling coupon giant Groupon , recently promoted Eric Lefkofsky to the role of CEO, replacing the ousted Andrew Mason. This gave Groupon a post earnings boost, with the share price jumping 19% , as well as a $300 million share buyback. This bit of positive news can be seen as a start of Groupon's recovery after two brutal post-IPO years, but there are still challenges ahead, and there are some questions that will follow Mr. Lefkofsky on Groupon's future.

How do you keep local merchants coming back?

This has been one of Groupon's recurring problems since the company went public. Local merchants that advertise on Groupon run into problems regarding customers only shopping when they have Groupon vouchers, creating a dependency on Groupon for customer traffic.

Groupon has combated this by limiting how many coupons are sold to customers as well as time limits for purchases, but the dependency problem still lingers. Groupon sells long-term deal contracts with retailers to post the same deals periodically. 

The goal is to help these merchants out, but has instead been more of a short-term stimulus than creating long term customers, but businesses don't mind discounting prices to get customers through the door. A quick browse on Yelp  mobile app shows numerous local businesses offering discounts or free items for "checking in" there, while Yelp rewards regular customers with profile badges, increasing foot traffic. The discounts are smaller (at face value) than Groupon, but Yelp's clientele also pay for premium advertising. This helped Yelp earn $55 million in revenue last quarter, and report a 62% increase in premium business accounts year over year. 

Groupon has to encourage people to be regular customers at local businesses, rather than just be a Groupon bargain hunter. Otherwise, local merchants will not sign on to Groupon and instead deal with Yelp or other means of advertising.

How will you take advantage of the increase in mobile users?

One important bit of news from Groupon's second quarter earnings was the increase in mobile transactions in North America by 30-50% year over year. This drove the $40 million increase in quarterly earnings year over year, as more people rely on mobile phones rather than desktop computers.

However, this has not appeared to benefit local advertisers. Local business went from being 65% of Groupon's revenue to just 57%, not where Groupon needs to be. As people become more mobile, they will want to know about a certain local business climate. With Groupon catering to high-end local businesses that thrive when offering specialty coupons at a deep discount, a lot of local businesses are left out.

Having cheaper, smaller discounts would broaden the business base, resulting in more mobile purchases. An industry study shows that 7 out of 8 proposed deals are rejected before even going to market, limiting the selection. If Groupon were to relax that policy, more local businesses would be inclined to use Groupon. Non-Groupon foot traffic would increase and boost same-store sales, an important profit source for small businesses.

What will you do differently?

This might be the most important question facing Mr. Lefkofsky in the wake of Andrew Mason's departure. During Mr. Mason's tenure, Groupon fell from its $20 IPO price to $5/share, and declines in daily deal purchases and local business involvement. With a new captain, investors will be wanting to see what he does to revamp the company, like the expectations being placed on Zynga's  new boss Don Mattrick.

Mr. Mattrick's company is in more dire straits than Groupon, but the dynamics are the same. Zynga started out hot selling online games on Facebook, then fell off, and is now trying to retool. Like Groupon, Zynga is now trying to use the upsurge in mobile-phone users to its advantage.

Over the last three years, Zynga has seen its daily to monthly active user ratio (DAU/MAU) fall from 26% in 2011 to 21% this year, representing 20 million DAUs and 41 million MAUs. This means that Zynga has the task of trying to increase the number of regular gamers, which drove Mr. Mattrick to go get Draw Something from OMGPOP, a popular, interactive smartphone game. In addition, new titles such as a FarmVille sequel and spinoffs like ChefVille and The Ville are in the works, hoping to drive MAUs to be DAUs, as well as regrow the customer base.

Groupon's 3Q forward projections show losses similar to the second quarter projections, which were $0.01/share, or $7.6 million. This was less than expected, but still not ideal. It may take a quarter or two to mold Groupon in the Lefkofsky image, but if Groupon can make small businesses the crux of the company, this is a service that will be more customized to the mobile clientele, and will drive revenues and profits as more connections are bridged with local businesses.

Mr. Lefkofsky also has to make Groupon look like a good investment. The stock price has jumped 40% in the last year, which would be seen as a sign of improvement. Also a sign of growth can be found in the P/B ratio of 8.9. Clearly, analysts see potential in this to grow further, and a justification that there is a demand for a service like this in the Internet community. 

However, there is a price problem. It's forward P/E ratio stands at 38, which is an expensive place to be despite trading at only $10/share, but may mean that the company may be turning more consistent profits in the future. To do so though, Mr. Lefkofsky has to have a better cash flow than the $266.8 million that was reported in 2012 if he wants to erase the 3.9% profit deficit the company is running. 

Conclusion

Investors seem to approve of the change at the top thus far, given the potential for profit and strong P/B ratios, but it may take a while for Groupon to become a buy. At the moment, Yelp has a stronger allure because of the more frequent usage and connection with local businesses, but has less monetary opportunity than Groupon. If Lefkofsky brings fresh ideas to the table though, it may be a stock to watch again.