|Shares Out. (in M):||90||P/E||n/a||n/a|
|Market Cap (in $M):||2,520||P/FCF||n/a||n/a|
|Net Debt (in $M):||213||EBIT||-50||-25|
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Short Coupons.com (COUP) at $28/share
Business description: Coupons.com (COUP) is the largest distributor of digital coupons for the US consumer packaged goods (CPG) industry. Since its founding in 1998, the company has generated 16 years of losses and negative cash flows. The company generated 2012 and 2013 revenue of $112MM and $168MM. The company completed its IPO on March 6, 2014 at $16/share.
Investment Thesis: At $28/share, COUP has a market cap of $2.5BN (90MM diluted shares) or 11x price/2014E sales. Despite recent growth (40% rev. CAGR from 2010-2013), the company plays in a limited niche where it already has ~80% market share and where the opportunity from print-to-digital conversion is not large enough to justify the current valuation. The CPG industry’s aggregate coupon distribution spend of ~$3BN is unlikely to grow dramatically, while print-to-digital conversion is playing out slowly as CPGs remain cautious about ROIs from an untested promotional channel (digital grew from 1% to 7% of total coupon redemptions over the past 6 years).
Price Target: Conservative base case of $19/share (32% downside to current) assuming (1) digital reaches 25% of coupon redemptions by 2016 (from 7% in 2013), (2) COUP holds its current 84% market share in digital despite flimsy barriers to entry, (3) COUP achieves a 15% net income margin, and (4) stock re-rates to 18x fwd P/E consistent with Retailmenot and other mature internet properties. In a reasonable bear case the stock trades down to $8/share.
COUP business model
COUP is a US-only online coupon distributor for the consumer packaged goods (CPG) industry. COUP's coupons.com website represents an online alternative to conventional Sunday-paper coupons that provide manufacturer-funded discounts (~50¢ to $2.00) on purchases of groceries and household goods. CPG brands (e.g. General Mills, P&G, Kraft) have historically relied on physical newspapers, magazines and direct mail to distribute coupons, but now can distribute online through the coupons.com site or any of COUP’s third-party affiliate sites. The websites and coupons are free of charge for the consumer.
Consumers browse the www.coupons.com homepage and click on (or “clip”) coupons, then print the selected coupons at home using COUP’s browser plugin (which is required and installs through a quick download). The customer then brings the printout to a participating store to redeem the discount at checkout. This method of distribution is known as print-at-home (“PAH”).
In addition to PAH coupons, COUP offers paperless digital coupons through its network of affiliated retailer websites. The retailer posts COUP’s coupons to its own website and receives a fee from COUP each time a customer downloads a coupon. Rather than printing at home, a consumer on the affiliate website downloads coupons to a personal loyalty account with the retailer; the coupons are then redeemed automatically when the consumer checks out with a loyalty card. Coupons delivered in this way (referred to as “load-to-card” or “L2C” coupons) do not require a printed paper coupon. While COUP does not disclose revenue split between PAH and L2C, data provider Inmar estimates the 2013 split for all distributors at roughly 55/45 PAH/L2C.
COUP earns revenue two ways: (1) fees received from the CPG manufacturer (e.g. P&G) each time a consumer either prints a coupon on coupons.com or downloads a coupon from an affiliate retailer website to a loyalty account; and (2) display advertising fees from banner ads on www.coupons.com. While historical revenue is not split out by coupons vs. ad clicks, COUP disclosed the split at ~80/20 coupon/ads in both 1Q13 and 1Q14. COUP’s overall revenue per transaction (per coupon printed or downloaded) has been stable around 12-13¢ in all years since 2009. COUP’s 2013 revenue was $168MM and management guides to 2014 revenue of $220MM.
On April 24th 2014 COUP launched RetailerIQ, a software platform enabling retailers to integrate digital CPG coupons into their shopper loyalty programs. The platform consists of (1) a new software tool to integrate COUP coupons into the retailer’s loyalty program by embedding coupons into e-receipts (delivered to the customer over email or SMS), and (2) software tools for the retailer to customize coupon offers based on a consumer’s purchase history. COUP launched the RetailerIQ product with Walgreens at 8,000 locations during 2Q14, and has signed agreements with 5 other top-10 US grocery/drug merchandisers with rollout in 2H14 and 2015. Management expects revenue from RetailerIQ to begin in 2H14.
COUP’s objectives in launching RetailerIQ are twofold: First, integrate coupons into e-receipts and retailer smartphone apps to increase consumer exposure and redemption rates due to targeting; and second, shift the business model away from desktop print-at-home and into smartphone-based paperless coupons, a more user-friendly format. COUP is clearly focused on transitioning its business toward paperless L2C coupons and away from the cumbersome print-at-home (PAH) format.
COUP’s existing business already integrates paperless L2C coupons into retailer loyalty programs. The only innovation provided by RetailerIQ is a new set of tools for the retailer to custom-target the coupons shown to consumers (which ostensibly will boost redemption rates). But at the end of the day, this is just an update to COUP’s existing L2C offering, not an entirely new product.
RetailerIQ offers three benefits to retailers: (1) the retailer receives a payment from COUP for every coupon downloaded over the platform, (2) broader coupon use is intended to boost sales which is good for the retailer, and (3) the coupon program can be used to attract more customers to the retailer’s loyalty program which improves customer stickiness.
Distribution and redemption volume
According to Inmar, CPGs distributed 329Bn coupons in 2013 including 2.3Bn digital coupons printed at home or downloaded to a loyalty account. The digital coupons were split 1.3Bn in PAH and 1.0Bn in L2C.
The redemption rate on traditional coupons in 2013 was 0.8% (2.7Bn redemptions), versus 11.4% for print-at-home (145MM redemptions) and 6.3% for L2C (66MM redemptions). Note that the digital and traditional redemption rates are not apples-to-apples since the act of printing or saving a digital coupon makes someone much more likely to redeem than someone who simply receives a coupon with their newspaper.
Below are links to coupon industry reports from Inmar and NCH:
Historical industry growth
Not surprisingly, print-based CPG coupons have come under pressure over the past decade as newspaper readership has declined and digital coupons have taken share. Data from NCH (cited in the COUP prospectus) indicates the average redemption rate on traditional coupons fell from 1.5% in 2000 to 0.6% in 2013 (Inmar reports the 2013 rate at 0.8%).
According to Inmar, digital has grown as a percentage of total redemptions from 1.0% in 2008 (26MM redemptions) to 7.3% in 2013 (211MM redemptions). At the same time, traditional coupon redemptions have fallen only modestly, from 3.0Bn redemptions in 2005 to 2.7Bn in 2013 (-1.3% CAGR). Below is the annual redemption volume from 2008 to 2013:
Industry-Wide Redemption Volume – Traditional/Digital:
2008: 2.57Bn / 26MM
2009: 3.25Bn / 50MM
2010: 3.21Bn / 92MM
2011: 3.34Bn / 165MM
2012: 2.74Bn / 165MM
2013: 2.69Bn / 211MM
Competition and Barriers to Entry
Historical market share
COUP’s 2013 transaction volume (defined as PAH coupons printed or L2C coupons saved) was 1.3Bn, versus total US digital coupon volume of 2.3Bn, implying 57% COUP market share. However, share of wallet is better measured by redemption volume rather than transaction volume, since redemption rates differ across distributors and should ultimately govern the price CPGs pay per transaction. COUP has posted redemption rates significantly above the industry average: 2012 redemption rate was reported at 15.1% versus 10.3% industry average for digital coupons, implying COUP’s share of digital redemptions is 84%.
For years other than 2012, COUP only reports transaction volume (not redemption rate). Below is COUP’s annual share of US digital coupon transaction volume based on data from Inmar:
COUP share of US digital coupon transactions:
Other players offering PAH or L2C digital coupons include Redplum.com (owned by Valassis Communications, formerly NYSE:VCI and purchased by Ron Perlman in Q4 2013), Smartsource.com (owned by News Corp), Hopster.com and Savingstar.com. Valassis and Smartsource hold a duopoly over the traditional print-based coupon distribution industry, but have been far less successful in the digital market despite their established relationships with brands and retailers through the print-based channel.
Based on coupon inventory (the number of coupon offers available on each site), COUP holds 60% market share (~300 offers out of ~500 total offered across the sites listed above).
In 2011 Google acquired a digital coupon platform called Zavers, but last week announced it was shutting the operation down. Catalina Marketing, another digital coupon player, recently shut down its web platform but still operates in-store kiosks distributing CPG coupons to shoppers.
Digital coupon distribution is a competitive industry with multiple scale players. As digital grows, I expect the industry will attract new entrants and competition will intensify. That said, there are some soft barriers to entry that should help COUP maintain its leadership position:
1) Exclusivity with CPG brands: Because CPGs want control over how many times a given consumer redeems each coupon, CPGs usually use a single distributor for each coupon offer (which expires after ~2 months on average). COUP talks about brand exclusivity as one of its competitive moats. However, each CPG works with multiple distributors for different coupon offers, meaning a given CPG does not have switching costs to change coupon distributors. For example, Unilever currently has different coupons listed on both Coupons.com and Redplum.com; similarly Dole currently has coupons listed on both Smartsource.com and Coupons.com.
2) Publishing exclusivity with retailers: For many retailers, COUP is the exclusive provider of L2C coupons published on the retailer’s website. For instance, the coupons listed on Walgreens.com are exclusively provided by COUP.
3) Integration with retailers’ point-of-sale systems: This is not a barrier to entry today, since retailers currently accept L2C coupons from multiple distributors (e.g. Kroger accepts L2C coupons from both Redplum and Coupons.com). However COUP’s RetailerIQ system is seeking to make COUP the sole provider of embedded e-receipt coupons, which would provide some competitive edge.
While exclusivity with CPGs and retailers may provide short-run barriers to entry, it is hard to believe CPGs will not switch to a distributor who offers the same service cheaper, especially when large retailers are willing to accept digital coupons from multiple distributors. On closer inspection, none of the barriers to entry that COUP talks about can prevent price-based competition and new entrants if/when the digital coupon industry takes off.
TAM Sizing – US Coupon Industry
The most important variables driving COUP’s earnings potential are (1) aggregate CPG spend on coupon distribution (i.e. COUP’s TAM), and (2) COUP’s share of that spend.
So how much do CPGs spend today on coupon distribution (both print and digital)? COUP estimates this value between $2-4Bn, which we can check as follows: COUP earns ~13¢ per coupon printed or saved to a loyalty account (including associated ad spend), and reports a redemption rate of 15%, which implies the CPG ultimately pays COUP ~87¢ for each redeemed coupon. If we assume distribution payment per redemption is similar across digital and traditional, then total distribution spend would be $2.5Bn. This math is consistent with estimates I’ve seen for distribution cost of freestanding insert (FSI) coupons in newspapers / direct mail of $0.005-$0.01 per coupon. On a base of 329 billion total coupons, those figures imply aggregate distribution spend of $1.6-3.3Bn.
Article estimating coupon distribution cost for FSI at $0.005-0.006 per coupon: http://eliswed.blogspot.com/2012/01/us-coupons-distribution-cost-250-of.html
2005 patent application citing FSI coupon distribution cost per redemption of $0.92 (versus $0.87 estimate above): http://www.google.com/patents/US20050149404
The next question is whether aggregate spend on coupon distribution can grow as digital takes share. I don’t think the shift to digital will cause this spend to grow dramatically beyond the current level of ~$2.5bn. The CPG's willingness to pay to distribute a coupon is based on (1) expected redemption rate, and (2) ROI on redemptions. Unredeemed coupons provide little benefit to the CPG manufacturer, so the redemption rate should set the price. That is why distributing through COUP costs ~13¢ per coupon printed or downloaded versus ~0.5-1.0¢ cost to print a coupon in the newspaper. Digital coupons cost 15-20x more but have redemption rates of 10-15% versus <1% for print-based coupons. It is clear that CPGs’ willingness to pay for coupon distribution is a function of redemption rate, not distribution volume.
So in order for aggregate coupon distribution spend to grow, redemptions need to grow. The problem with growth in redemption volume is that it erodes the manufacturer’s ROI. Each coupon redemption creates a cost on the manufacturer (typically $0.50-2.00) that only generates an ROI to the extent it attracts incremental purchases by boosting a good’s relative attractiveness. If the share of goods in a store covered by coupons suddenly tripled, the relative attractiveness of a given couponed good would decline. The value of a coupon to the consumer (and thus its ability to motivate incremental sales and generate ROI) is dependent on its scarcity – if all goods were couponed at all times, coupons would drive no incremental sales.
Even if new digital coupon technology causes the volume of coupon redemptions to grow, the willingness of CPGs to pay for those redemptions must decrease as redemption volume rises, causing price-per-redemption to fall from its current level of ~90¢.
That is not to say the shift to digital coupons will create zero incremental coupon distribution spend. But I am skeptical distribution spend can grow dramatically above its current level of ~$2.5Bn as the bulls predict (RBC’s initiation report has COUP’s TAM at $6-8Bn). There is a natural upper bound on the total willingness of CPGs to spend on coupon-based promotion, and the economics of coupon spend are governed by ROI which declines as coupon volume grows.
Further, it seems unlikely that using digital versus print coupons will alter ROI economics for the CPG. If anything the ROI for digital redemptions will be lower than for print-based coupons, since consumers who were already going to buy a given product can now check their phone for coupons in the checkout line.
If we assume the total pie of CPG coupon distribution spend will remain in the $3Bn range going forward, the next question is how much share digital coupons will capture from traditional coupons. Over the last 6 years digital has grown from 1.0% of total redemptions to 7.3% in 2013.
Based on the experience in other media markets that have undergone a print-to-digital transition, it seem implausible that the coupon industry will convert 100% from print to digital, or even 70%. Consider the following: In US advertising in 2013, print captured 27% of total ad spend, while online only captured 22%-- meaning that digital has yet to surpass print-based advertising in terms of ad dollars captured.
Similarly, in the local news industry, which is arguably a better analogue for coupon distribution due to the local nature of coupons, print-based newspapers still hold over 50% readership share versus online news. Print share of overall news readership is lower when you factor in national news, but 60% of the population still reads a print newspaper at least once a week. Given that coupons in the Sunday newspaper still represent 90% of the coupon industry, this fact further discredits the idea that coupons will shift predominantly to digital in the near term.
Considering that print holds more market share than digital in both aggregate advertising dollars and local news readership today, I believe a similar pattern will prevail in other media markets undergoing print-to-digital conversion. These shifts take place over many years and print-based media rarely shrink to zero. As such, I expect a gradual shift from print-based coupons to digital (as we have seen over the past six years), with print maintaining a meaningful share in the long run. Keep in mind that digital has been in the market since 2008 but only captured 7% share of redemptions.
But let's just say for argument's sake that digital coupons reach 50% penetration by 2017 (as measured by redemption volume), and that COUP manages to maintain its 84% market share of redemptions. That gets us to 2017 revenue for COUP of $1.3Bn – which is the most aggressive bull scenario you can run. In this scenario, COUP totally saturates its TAM, but only generates $189MM of net income (assuming 15% net income margin). This compares to a current market cap of $2.6Bn.
Below is a sensitivity showing COUP’s revenue and net income at a range of digital penetration percentages (i.e. digital redemptions / total redemptions), assuming 84% COUP market share and 15% net income margin:
Digital share COUP Revenue Net Income @ 15% margin
7% $177 $27
10% 252 38
15% 379 57
20% 505 76
30% 757 114
40% 1,010 151
50% 1,262 189
60% 1,515 227
70% 1,767 265
80% 2,020 303
90% 2,272 341
100% 2,524 379
COUP’s COGS has been remarkably consistent around 30% of sales since 2009 (COGS consists of distribution fees paid to affiliate retailer websites). On the opex line, however, the company argues it will achieve significant cost leverage as it grows. While there should be some degree of operating leverage (coupon clicks create zero marginal opex cost), the company has only achieved a small degree of operating leverage in the past five years, growing gross profit at a 43% CAGR from 2009-2013 while opex grew at 36% CAGR.
The bull argument that opex is infinitely scalable for this business is unproven and unlikely. Developing and rolling out new distribution channels (e.g. RetailerIQ) needed to drive growth will require significant R&D and sales & marketing, along with major capex to cover server/IT equipment and capitalized software. Note that the CFO said on the Q1 call that the sequential jump in opex from $36.5MM to $44.8MM was due to development costs and rollout related to the RetailerIQ launch (opex jumped from 69% of revenue in 4Q13 to 87% of revenue in 1Q14).
EBIT margin benchmarking – digital marketing/software (2013 / 2012 / 2011):
Retailmenot (retail apparel coupons, $210MM in 2013 revenue): 25% / 31% / 48%
Valassis (print coupons and digital coupons): 10% / 10% / 10%
Conversant (digital marketing services for marketers and ad agencies): 29% / 25% / 39%
Criteo (digital advertising tech platform): 2.4% / 3.3% / 6.9%
The margin benchmarking set above includes public companies in the digital media/advertising sector with positive operating income. The closest public comp to COUP is Retailmenot (SALE), which operates a digital coupon marketplace for e-commerce coupon codes (does not compete with COUP – SALE’s customers are e-commerce retailers).
As Retailmenot grew revenue from $80MM in 2011 to $210MM in 2013, its operating margins fell from 48% to 25% and net income margins fell from 21% to 15% (i.e. operating deleveraging). Much of this deleveraging was attributable dramatic ramp-up in sales and marketing and product development costs, which grew much faster than revenue.
It’s difficult to predict where COUP’s margins will wind up once the company turns EBIT-positive, but based on the above benchmarking a reasonable range could be 10-25% EBIT, and 7-15% net income (assuming tax rate of 35%).
At $28/share, COUP is valued at a market cap of $2.5Bn, or price/sales of 11.4x 2014E, 8.6x 2015E and 6.8x 2016E (all consensus). In order for today’s valuation to look reasonable by year-end 2015 (say 18x forward P/E, consistent with Retailmenot and mature web businesses like search), the company would need to generate 2016E net income of ~$150MM, which on the assumption of 15% net income margin would require $1,000MM of 2016 revenue (4.5x management’s 2014 revenue guidance of $220MM). Achieving $1bn in revenue would require digital penetration of the coupon industry to immediately balloon, growing from 7% in 2013 to 40% by 2016. This scenario also assumes (1) COUP maintains its 84% market share of digital coupon distribution, and (2) COUP achieves 15% net income margins.
Simply put, too many things need to go right for today’s stock price to begin to make sense. At $28 the stock prices in a dramatic near-term spike in digital coupon penetration, COUP market share maintained at 80%+ despite flimsy barriers to entry, and COUP achieving mid-teen net income margins. You need to believe all of these assumptions on a business that has never generated profit or cash flow despite 16 years of operations, in an industry that is only gradually transitioning toward digital, and for which growth is capped by the coupon promotion budgets of CPG manufacturers.
Bull Case: In my view the downside risk on shorting COUP is limited – even in an aggressive bull case where digital takes 50% share of the coupon industry by 2016 (vs. 7% share today), the share price at 18x fwd P/E would only reach $38 (assuming COUP market share at 84%, 15% net income margin).
Base Case: A base case 2016 digital penetration rate of 25% (~3x today’s penetration) and COUP market share of 84% would imply a $19 share price 12 months from now.
Bear Case: The distribution of returns here is skewed far to the downside. A realistic bear case assumes only 20% digital penetration by 2016, 10% net income margins, and COUP market share of 70%, resulting in a share price of $8.50.
As a side note, the sell-side is relatively bearish on the name: GS initiated at neutral with a $21 price target which it lowered to $19 on 5/8; BAML price target is $30 (5/30) and RBC price target is $26 (5/8).
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