Valuation

Let’s start by throw out the Twitter and Facebook valuation comparisons. Facebook recently reached valuations between $33 billion and $50 billion on Second Market. Various online sources appear to pin Facebook’s revenues anywhere from $1.2 billion to $2.0 billion in 2010. The Company only became cash flow positive in Q2 2009. Even by the loftiest of expectations, Facebook is trading between 16x and 25x revenue likely near 100x cash flow earnings. Twitter did not announce a monetization strategy until April of this year and was projecting just $140 million in 2010 revenue in 2009. If they hit their projection, this would equate to 28x revenue. But, let’s be honest, Groupon is a vastly different business than Facebook and Twitter so let’s literally “throw out” these valuations (for now).

To me, Groupon is best compared to an internet retailer. By way of precedent transaction, Zappos was purchased for $1.2 billion by Amazon in 2009 which was essentially a 1.2x revenue multiple. However, Zappos was well known to run razor thin margins, rumored to be well in the single-digits. If this is true, then Zappos likely changed hands at well over a 30x EV/EBITDA multiple.

Comparing to larger, more mature e-tailers, Amazon trades at 2.6x revenue and 39.7x EV/EBITDA. EBay trades at 4.2x revenue and 11.8x EV/EBITDA.* The disparity in these metrics likely lies in the fact that E-Bay runs high-teens operating margins and Amazon runs low-single digit margins, but Amazon has been growing revenues at over 30% year-over-year while E-Bay has seemingly hit a growth wall over the last few years.

So, what does this all mean to Groupon? Consensus seems to be that Groupon will have sales around $500 million this year. However, it has grown dramatically month-over-month and could be selling at a run-rate in excess of an annualized $600 million in gross sales. Assuming Groupon typically takes 50% of gross sales as its cut and then must pay overhead. Groupon’s overhead cost structure is likely to be significantly better than that of most tech companies with less of demand for hardware and most of its costs in personnel as the site doesn’t have to do any more than handle requests one deal at a time (no videos, photos, messages, etc.). It’s not hard to imagine that Groupon’s EBITDA margins are closer to that of an EBay, and possibly better. Let’s assume they are 25%. Additionally, relative to the tech startups and tech-heavy retailers I’ve described above, Groupon’s business model is likely working capital negative and lower capital intensity which would mean that Groupon’s EBITDA quality (as a proxy for cash flow) is likely higher than the others above.

Given these qualities of the Groupon business, it would seem fair that Groupon would deserve an EV/EBITDA valuation at the high end of the range for retailers. Groupon is a younger company than Amazon, but has a business model which is fundamentally more limited, so I’ll split the difference and apply the exact same multiple (39.7x). So, how much is Groupon worth? $600 million x 25% x 39.7 = $6.0 billion. Well, suddenly I feel a little better about Google’s valuation. Do you?

* I acknowledge that I’ve mixed enterprise value and equity value metrics, but Groupon is likely a debt-free startup, I’m taking the liberty of assuming enterprise value and equity value are close.

Considerations/Risks to the Valuation

Clearly, Google is paying a full price. Moreover, depending on which metric drive’s Google’s public valuation, this deal may prove to not be value accretive. Google is currently trading at 6.5x revenue but just 13.0x EV/EBITDA. Accretion/dilution aside, on a standalone basis, I wouldn’t call Amazon’s stock cheap and Groupon has some obvious limitations to its appeal and value proposition which could limit its trajectory.

Additionally, the above analysis is clearly based on some aggressive assumptions. Even assuming that some of them are accurate today, there are serious questions about whether Groupon can sustain high-levels of profitability given increasing competition and some criticisms by partners over the sustainability of offering 75%-90% discounts.

All this said, Google is not buying Groupon as a standalone business and a significant case could be made for valuation upside due to Groupon’s strategic value. Ostensibly, Google believes that it can integrate Groupon as part of a broader customer experience platform and enable various other parts of its service offering – particularly in local advertising. If this is true, could it be possible that Groupon can create value within Google more similar to the  stratospheric valuations that Facebook and Twitter and other “true web” startups garner?

Full disclosure: Author is long shares of GOOG at the time of writing.

To whom it may concern:

I recently returned from a trip to China and had several terrific experiences at Burger King locations there. With the hype of the Olympics still in the air and increased interest by Americans in all things Chinese, I think it’s a great time for your Company to think about bringing one of your best menu items in the world to the US – the Spicy “Ma-La” Whopper.

To be honest, when here in the US, I typically spend more of my fast food dollars at competitors to Burger King mostly because I feel that Burger King lacks some pizzazz in their product offerings. In Asia, on the other hand, Burger King is one of the few western chains that I have actively sougt out ever since I first ate a Ma-La Whopper two years ago on a trip to Taiwan. When I went to China this summer, I was thrilled to see that it was also on the menu there. The sandwich is a tremendous culinary achievement and the fact that it hasn’t been brought to the United States surprises me especially given the interest in “spicy” style sandwiches that have been offered at other competing fast food restaurants – the Wendy’s Spicy Chicken and the Wendy’s Four Alarm Burger being the most famous of the bunch.

Admittedly, the Ma-La Whopper may not have a form factor that would play terrifically in the United States. The sauce offers a distinctly Asian spiciness which may be somewhat different from what most Americans expect having grown up on Tex-Mex style spices – chipotle, jalapenos, etc. But, I think you will find that Asian “spice” can go a long way even in the United States. Ask anyone who’s tried Sriracha and they’ll tell you that they think it can go well on anything. I believe this to be true of the Burger King “Ma-La” sauce. The sauce itself is a bit thin which I like, but may be messy for some people’s tastes. A simple change in the formula to add a thickening agent like tapioca starch or xantham gum would be easy or another solution would be to mix the sauce into the base mayonnaise which is used on the burger already. One might also consider incorporating the same spices into the burger patty, but I could see this as being less feasible since the Company would ave to source pattie which could only be used for one sandwich.

All-in-al, I belive it’s a terrific time to introduce a sandwich I believe will be highly successful here in the United States and which would make me an avid Burger King eater here at home as well as abroad.

Sincerely,

[The Curious Investor]

And, the response from Burger King? Click to read on…

Dear [Curious Investor],

Burger King Corporation receives many ideas and suggestions from persons outside our organization. However, we spend a great deal of time, money and effort towards the development and implementation of new services, products, techniques and equipment, which we have used or may use in the future. In view of htis, it is not surprising that many of the suggestions made to us from outside our company are already known or available to us through the efforts of our staff. While we appreciate your interest in presenting an idea or suggestion to us, it is Burger King Corporation’s policy not to accept or review any unsolicited idea or suggestion. We do this in order to avoid any possible confusion or misunderstanding regarding the ownership of an idea or submission.

Thank you for taking the time to contact Burger King Corporation.

Sincerely,

Yosha

Consumer Response Representative

Admittedly, the difference between my letter to Burger King and my letter to McDonald’s was that in one case I wrote to provide an unsolicited suggestion whereas in the other case I simply wrote to provide customer feedback. That being said, my letter to Burger King was significantly more positive than my letter to McDonald’s yet the most cordial and enthusiastic response came from McDonald’s. Second off, while portions of the McDonald’s letter seemed canned, the Burger King letter was clearly a template. While they couldn’t admit to having read my letter for legal reasons, it was clear they had read it enough to respond appropriately to an “unsolicited suggestion.” Yet, somehow, they hadn’t read the letter well enough to realize all I was asking for was for the importation of an already existent Burger King product which should lend no confusion over ownership.

Moreover, Burger King very clearly chose not to take advantage of a great opportunity to lock in someone who was a borderline superfan whereas McDonald’s still tried to sway my opinion of their new premium drinks despite my writing a letter expressing my displeasure with them. Burger King’s letter was terse, formulaic, rejection-like and signed by a “Consumer Response Representative” without a last name while McDonald’s provided a seemingly personal response from a “Vice President of the U.S. Customer Satisfaction Department.” Even if this was merely for show, McDonald’s clearly has a customer service focus and Burger King is seemingly more interested in improbable legalities than actually making their customers feel like they can actually “have it your way.”

It is interesting to note that the “Angry Whopper” was unveiled later in the year which may have been the source of Burger King’s skittishness. But, couldn’t they have responded with the same safe harbor language but added a heads up about a new product that I would be likely to enjoy? At the very least, could they show more appreciation while still reserving their rights over their own in-house development? Couldn’t they extend me a job to help them develop and market great new products!?

Whatever the case, it is clear that the “tone at the top” at Burger King is not a true customer service focus, but just the standard corporate ass-covering beaurocracy that we have come to expect from large companies. While this isn’t enough to sway a decision to invest in one business versus another, it is a worrisome sign especially for a consumer experience dependent business and I will admit it did factor at least marginally into my decision to invest in McDonald’s versus Burger King.

Full Disclosure: Author is long shares of MCD at the time of writing. No position in other stocks mentioned.

Truth is, you don’t need to be a 5% shareholder or even a shareholder at all, to write a letter to a company you deal with. Just look around for the “comments and suggestions” addresses on the packaging of the products you use. Or, simply go online and look for some customer service e-mail addresses. In my experience, these little customer service entreats are often a great way to test how well a company responds to the demands of their customers and whether or not they’re nimble and persuasive or stubborn and uncooperative. I don’t think I have to say, investing in nimble businesses which can convince customers of their value proposition is usually a winning bet.

Let’s start with a company I recently wrote about – McDonald’s. Last summer, I tried out McDonald’s new beverages – Sweet Tea and Caramel Iced Coffee. In my opinions, they were cloyingy sweet and just completey off the mark and unenjoyable. I couldn’t help but write an e-mail to express my displeasure.

Dear McDonald’s,

I am writing as a result of a few recent visits to McDonald‘s that have left me less than enthused with your new product offerings – particularly the new sweet tea and caramel iced coffee drinks. I’m not sure what product trials the Company went through or how it decided on its formulations but I’ve found both drinks to be sickly sweet, nearly undrinkable. I don’t believe that this is a result of my personal preference or a misstep at an individual McDonald‘s as I’ve given the drinks a try at multiple locations.

While a good southern sweet tea is traditionally rather sweet, one would expect a hint of tea flavor to remain. The caramel iced coffee is even worse, tasting like sugar syrup and milk without even a trace of coffee. I thought that these new drink offerings were a terrific way to highlight McDonald‘s hot tea and coffee offerings which are truly underrated, but it’s clear that these two new cold beverages were not designed to capitalize on the quality of your base tea and coffees.

These poor drinks are particularly disappointing to me given McDonald‘s success rolling out some terrific new products like the southern style chicken, mcskillet burrito, and multiple incarnations of the snack wrap. I would hope that the Company is able to continue its terrific innovation and not slip back into the cycle of misfires like the failed sandwich releases in the 1990s that left me disenchanted with the overall McDonald‘s franchise.

Sincerely,
[The Curious Investor]

Lo and behold! McDonald’s wrote back. Later in the year, so maybe they aren’t the most responsive, but they were impressive. See their reply after the jump…

Despite my firing off an e-mail, McDonald’s, in fact, took the time to type up a personalized letter and mail it.

Dear [The Curious Investor]:

As 2008 winds down and the holidays are upon us, I wanted to take this opportunity to say thank you – we value you as a customer.

During this year, you took the time to contact McDonald’s to share feedback or request information about one of our coffee products. You contacting us gives us an opportunity to learn from you, which allows us to better meet your needs and expectations. We want you to know that we appreciate your comments and we thank you for your business.

In appreciation we’d like to invite you and a friend to stop by McDonald’s restaurant for a complimentary cup of Premium Roast coffee with the enclosed Be Our Guest cards. McDonald’s coffee is always brewed fresh every thirty minutes using 100 percent Arabica beans, the finest in the world. And, we have some exciting new products in our McCafe line of specialty coffees (such as creamy lattes, frothy cappuccinos and rich mochas) which are currently being introduced at many of our US restaurants – with even more to come in 2009! We hope you’l have the opportunity to enjoy these new products when they are available at your local McDonald’s

So again, Mr. Hung, thank you for taking the time to contact McDonald’s this year. We appreciate you and the opportunity to serve you. WE look forward to serving you in the coming year!

Sincerely,
Terri K. Capatosto
Vice President
U.S. Customer Satisfaction Department

Outside of the slow response and the somewhat canned line about our the nature of my inquiry, the customer letter does a perfect job communicating to a potentially unsatisfied customer. It’s enthusiastic, supportive, and appreciative despite the negative tone of my original letter.

More than this, McDonald’s takes advantage of an opportunity in front of a prospective customer by both educating the reader about a new product line and offering a free trial to get the prospective consumer back into a McDonald’s location. AND! They think enough to give a second free trial so as to create potential word of mouth advertising. Brilliant! In fact, I ended up giving both my free trials to friends and have become a fan of McDonald’s coffee. Though, I have to say, the sweet tea and caramel iced coffee are still sickly sweet. Maybe my tastes don’t quite converge with the rest of America’s.

The answer, not quite. But, Gap decided this time not to put all its eggs in a CEO much like it had when it was near single-handedly built by Mickey Drexler in the 80s and 90s and then attempted to find again in an overmatched Paul Pressler. Instead, Gap went with the operationally savvy CEO and brought in high-fashion designer – Patrick Robinson – to give him a hand. And, I have to say, a year later, their presence is felt.

Glenn Murphy initiated a buy back, began focusing on inventory management and margin dollars, and knew enough to shy away from the dangerously tempting game of chasing comp store sales growth. But, just focusing on efficiency does not a fashion retailer make. The thing that differentiates apparel retailers from all other retailers is that, more than any other industry, success in apparel is inexorably tied to finding a way to connect with the consumer. For Gap, this meant bringing back brand clout, establishing true target demographics for their three brands, and getting away from the discounting trap.

How can Gap do all this? Well, enter Patrick Robinson and this fall’s collection that has recently gone up on the Gap website. More importantly, take a cruise through the Old Navy, Gap, and Banana Republic online catalogs. What will you see? Gap has its mojo back. The color choices allow for mixing and matching, Gap and Old Navy are shedding their images as carrying “basics” and really showing up with everyday clothes that shouldn’t end up in a cameo on a Weird Al music video.

The “new classics” line couldn’t come at a better time with consumers scaling back purchases and less likely to be purchasing for the season more likely necessity shopping. The idea of classic, timeless looks that still give you a chance to express yourself could really resonate going forward. Add in Gap’s truly impressive embracement of web retailing with a terrific online shopping cart which allows for cross selling between it’s four major retailing properties – Old Navy, Gap, Banana Republic, and Piper Lime – and you have all the makings of more than an operational turn around, but a legitimate rebirth. It may be time to start taking a hard look at this company’s stock.

But, you know what? This might not just be a transient event. iPhone-mania could last well longer than the one-holiday wonder that was Tickle-Me Elmo. When the iPhone first came out, I jumped into Apple as a short-term trade knowing that the fervor and quick earnings boost would juice the stock which had just fallen precipitously for no real reason. I downplayed the impressiveness of the iPhone because I didn’t originally believe that the Apple model would work to truly “revolutionize” the smart phone industry. I wasn’t happy with the completely closed OS and I felt that Apple delivered a stunted product. With the release of the iPhone SDK and this new iPhone firmware (most importantly an App store), I am changing my mind. While I still believe that the Apple iPhone OS doesn’t necessarily have a leaps-and-bounds advantage over Google’s up-and-coming Android or Nokia’s Symbian systems (both of which will now duke it out for Smartphone marketshare), I have been convinced by a technology friend of mine that Apple’s product strategy and brand clout have given them a massive advantage in taking steps to dominating the rapidly emerging personal mobile computing business. For a better and more technical explanation, I defer to my good friend, Benny, in his two part series on “Why the iPhone is important” (Part 1, Part 2).

With this in mind, and no immediate “iPhone killers” on the horizon, I have upgraded my “trading” position in Apple to a “hold” and am gladly long. Could it be the next iPod? Well, with recurring revenue from the App store, a legion of developers excited and able to utilize the platform, and the press clout to drown out the advances of a disorganized band of competitors (BlackBerry, a Microsoft who hasn’t gotten mobile right since the appropriately named WinCE, whatever companies decide to try Android, and Nokia’s too-little-too-late attempt to promote Symbian), there’s a legitimate chance.

—————————————————————

On a related note: I have an idea for a very fun little web/iPhone development project and would be interested in partnering with someone with technology skills beyond mind. If you’re interested, please contact me and we can speak a little further on it.