$6 Billion in Groupon Market Cap Erased in Two Days

The timing on this short was more lucky than smart.  After another -15% performance, today Groupon (GRPN) is down to a more reasonable $10 B valuation.  Of course, the company is probably worth something closer to $5 B (a stock price of around $9).  This chart looks like GRPN is headed to $13 in a hurry...but it is very greedy to ask for more after a 38% drop in two days.  I'm a Market Monkey, not a Market Piggy.  

The Friday after Thanksgiving is typically a very light day in volume, and the price could come back against us in bad way.  Of course, a crisis is on the horizon and some type of short position is probably prudent. Groupon is still overvalued at $10 B.

But the Market Monkey thinks it better to close the position and head off into a long holiday. Had it gone the other way (going long at $17), we would be looking at a 44% gain in two days.  Let's be Eee, Eee, Ah, Ah...not Oink, Oink, Oink.  It's time to sell.  I might revisit this short again, but this is too much action in two days not to walk away.

Happy Thanksgiving Everyone!

MONKEY BUSINESS

Short Covering: GRPN @ $17.10 ($24.51)

Holding: AGQ ($79.85, $63.16, $54.10),  UGL @ $91.00, AVL($2.72), NFLX ($74.70)

Groupon down 14.9% today. It's better to be lucky than smart.

It's better to be lucky than smart.  But it's even better to be both.  

GRPN down 15% today, and off 18% since initiating a short yesterday.  This much movement warrants the need to start thinking about exiting.  I need to find out when the next earnings announcement is.  Any good news, especially news that is specifically planned to be part of their first earnings call is likely to trigger a short squeeze.  Be careful out there!

MONKEY BUSINESS

Holding: AGQ ($79.85, $63.16, $54.10),  UGL @ $91.00, AVL($2.72), NFLX ($74.70)

Short: GRPN ($24.51) 

Value of Groupon Stock (GRPN)

I think it's worth noting that I think Groupon is a brilliant idea.  I'm an avid customer.  I signed up for the service in November of 2008, which was the same month as the launch.  I think management is smart, I think their customer service is great, and I think the company has a great culture.

However, as of the close of business today, the market cap for GRPN is $15.04 B on revenues of $1.29 B and net income of $-686 MM.

Now, if you don't value stocks often, you may not realize how grossly out of whack that is.  They have a year-over-year revenue growth number of 426%.  That is flat out awesome.  No doubt about that.  However, it is plain to see from the chart below, that that revenue growth next year will be WAY lower.  A rough extrapolation of the line would project something in the range of 100%-200%.  Still great growth, but less than half of the current rate.  

Certainly the company is flush with IPO cash and may use it for aggressive growth into new markets, like Brazil and China.  So perhaps for another year or so, the company can keep revenue growth in the triple digits.  But even that is a stretch to me.

 

Marketing dollars (no matter how much) won't be able to drive growth at that rate for long.  It is simply too easy to to copy the business model.  We have already seen a litany of "daily deal" copycats sites show up (Living Social, KGB Deals, ScoutMob).  More problematically, legacy sites with lots of traffic, and long-lasting customer relationships are also getting into the daily deal business.  Newspaper sites, eBay, and online retailers are the biggest threats to Groupon's business model.  If they haven't launched them already, thousands of websites are trying to figure out how to launch daily deal services in the next year.

To use the language of the perhaps the most sensible billionaire, the "moat" around Groupon simply isn't wide enough.  The brand is great, the customer value proposition is great.  But at the end of the day, it will be very difficult for Groupon to grow into it's current valuation.

Even in the dot-com bubble, it was irresponsible to pay more that 10X revenues for companies.  Calculating values was very hard, since nearly none of them had earnings, and sometimes even revenues were hard to come by.  As an illustration of the absurdity, people tried valuing companies based on eyeballs when there was no revenue to value.

This brings us back to the current value of GRPN.  $16 B is 11X revenue and some gigantic multiple of future (not yet real) earnings. There is a rule of thumb that you company is worth an earnings multiple equal to the earnings growth rate.  GRPN has a multiple of 168X next years projected revenues.  That looks pretty good if you think that growth is 426%, but a year from now, that number will look more like 100% and that won't translate well at all.

This valuation multiple is simply too high for a company that is already showing signs of slowing revenue growth.  Of course, next year's revenues promise to be AMAZING, because the company will probably spend hundreds of millions on advertising.  But that will come at a huge cost to profit margins, which are already negative.

That said, it is worth noting that Groupon's model is a pre-paid model, and so the company will benefit from the carry interest on all those groupons being sold.  Here, people buy groupons and pay on the spot.  Groupon doesn't pay any money to the merchant until people actually use the groupons.  So, Groupon collects interest on all that money in the meantime.  Also, they will get to keep some percentage of the money spent on groupons that expire unused.  I expect that at some point in the future, there will be a class action law suit filed by Groupon merchants (or States Attorneys General) to reclaim some of the money spent on Groupons, but never redeemed.  The legal question being whether a Groupon is a gift card or a coupon.  So far, there has been no ruling, but there will be one day, I'm certain of it.

So a responsible investment analyst would make some projection of Groupon's revenues and apply some sort of discounted present value.  But the Market Monkey is not here to do math for you.  He is here simply to say that Groupon is great, but not at all worth $16 B.

MONKEY BUSINESS:

Shorting: GRPN @ $24.51

Buying: AGQ @ $54.10, AVL @ $2.72, NFLX @ $74.70
Holding: AGQ ($79.85, $63.16),  UGL @ $91.00

Big Moves in Precious Metals

It's a little bit difficult to make sense of the dramatic moves in gold and silver in the early hours of Monday morning.

As you can see in the chart above, silver fell all the way down to $26 from $31 in four hours of Asian trading on Monday morning, only to recover all the way back to $33 here at the open of US trading here on Tuesday.  That's a 27% move in 27 hours.  Gold had a similar panic and is also recovering very strongly.

There was a margin hike by both the US and Chinese metals exchanges on Friday, resulting in a number of forced liquidations on Monday.  Like the May takedown in silver, the logic of exchanges seems a little bit backwards.  If they are trying to keep the price stable, their tactics need some work.  Hiking margin rates right after at 15% drop...tends to result in a 30% drop.  Which is quite the opposite of stability.  However, if their goal is a massive collapse, then perhaps their tactics are right on.

The May action leaves open the possibility that more margin hikes may be in the cards.  But, this should be different, as we haven't had the same level of price appreciation that we saw in April.  The soverign debt problems are still here, and consequently I am still bullish on precious metals.  Though I'm already long silver (and taking a beating), I am using this dip to buy more.

Separately, there appears to be a multi-decade cup-and-handle formation on gold.  More on that later.


MONKEY BUSINESS:
Buying: AGQ @ $126.33,  UGL @ $91.00
Holding: AGQ ($159.70)

What Good is Operation Twist?

On Wednesday, the Federal Reserve announced a new program called "Operation Twist."  It is an open market action that involves selling long-term bonds and buying short-term bonds.  The effect of this that interest rates on long-term bonds fall, and interest rates on short-term bonds rise.  Visually, that leads to a flattening of the yield curve.

In the banking industry, you learn to HATE a flattening yield curve.  This is for two reasons. First, bank profitability is pretty simple.  Banks borrow money at short-term rates (savings accounts) and then lend money at long-term rates (consumer loans).  So, when the yield curve gets flat, the spread shrinks.  If you have any bank stocks, you should know that your bank's profits are about to get a lot smaller.  Secondly, the flattening yield curve is a precursor to an inverted yield-curve.  More often than not, that means a recession is ahead.  However, it's prone to some false positives.  I believe that the inverted yield curve has predicted 10 out of the last 7 recessions.  :)

I for one, don't see very strong benefits from Operation Twist.  But I don't think it's geared towards consumer behavior.  There is some possibilty that it makes long-term savings less appealling.  Combine this with the fact that short-term rates are basically still negative.  So if near-term savings are still worth zero and now long-term money is worth less, perhaps it will get people and companies that actually have cash to go out and spend it.  But for the folks that have no money (or REALLY need to hold on to the money they have) it doesn't really make much of an impact.

Again, I'm surprised that the Fed didn't announce QE3.  My guess is that there is enough dissention inside the board that they wont announce any easing action until this situation gets worse.  I can imagine that QE3 action followed by a European crisis would fuel the critics who believe that QE3 is not helpful.   So perhaps Bernake is waiting until AFTER the "Lehman Moment" to take action.  Politically, I can understand this...but I'm disappointed that politics has any more in this.

Oh well, it will be an interesting few months.  For better or worse, it is shaping up to be an echo of the fall of 2008.  Mostly for the worst.

MONKEY BUSINESS:

Holding: AGQ ($159.70)

Panic of 2011?

There was a headline yesterday what said we were on pace to be the third worst week on the Dow Jones in point terms ever.  I'm not sure where we finished.  But regardless of ranking, it wasn't a good week.

The sell off seems to have started in Europe on Thursday afternoon, just as the announcement of Operation Twist by the Federal Reserve was hitting the wires in the US.  I think it was an honest to goodness "perfect storm." Reports of bank runs starting in France and Italy, Germans making negative comments about the Greek austerity package, inaction by the US Fed, and then bad employment numbers.

I was really disappointed by the absence of QE3 on Wednesday and joined the stampeed on Thursday morning, selling many of my ETFs and trimming my silver position.  The selloff seemed a lot like panic, with nearly every asset class getting dropped in favor of plain old USDs.  No safe havens, just cash.  I saw a report that showed that margin positions have shrunk dramatically as well.  So, with gold and silver being sold off -- this was just an across the board "risk off" sell off.

The market action and price action feels a lot like the fall of 2008 again.  Everyone seems to be waiting for this time's "Lehman Moment."  Many people expect that it will come in the form of a European default...but sort of thing tends to go in slow motion...and I feel that a Lehman moment is more likely to unfold over 3 days, very unexpectly.  It is possible that it would a collapse in confidence in large bank, or perhaps the Euro itself.  In either case, this panic will turn into a bonefide crisis.

I think it will take several months for us to reach bottom.  There are too many icebergs in water for anyone to feel confident right now.

MONKEY BUSINESS:

Selling: FAS @ $10.38  ($12.70, $12.50), EDC @ $14.33 ($20.05), ERX @ $43.30 ($40.20)
Holding: AGQ ($159.70)

Bernake at Jackson Hole

Well, Bernake again came out and said that there would be no QE3 today.  So with two press conferences this month and a consistent message, one has got to believe that he is not going to engage in another round of QE unless we really need it.  So, I guess the world's financial markets will have to make due on their own.

I expect somewhat choppy markets ahead, but perhaps upwards as the panic in Europe has cooled off a bit.  I am buying some more upside exposure today via EDC and adding to my FAS position.

MONKEY BUSINESS: 

Buying:  FAS @ $12.70, EDC @ $20.05
Holding: AGQ ($159.70), FAS ($12.50), ERX ($40.20)

Doosy of a Day

Wow, the Dow finished the day at -634.  Pretty fierce, considering we had a number of negative triple digit days already last week.  As of 11pm ET tonight, the Dow futures are down another 285.  So tomorrow promises some very interesting market action.


Importantly, Bernake is scheduled to speak tomorrow.  At this press conference last year, he announced the programs which are commonly referred to as QE2 (Quantitative Easing), though evidently, the Chairman doesn't actually like that term.  Others refer to it as "money printing," which I would guess he prefers even less so.

A few points on what QE actually means.  First, most people think of QE as "printing money" and use it as an excuse to join the Tea Party.  I can see why people cringe at the idea of "money printing" because it evokes the idea of turning a crank and making something out of nothing.  However, QE is slightly different from that.  When the Fed engages in QE, they are really just buying US Treasury bonds and giving people "cash" for their bonds.  So, yes, it is "printing money" in the sense that there is more actual money in the system, but it is not creating money out of nothing.  It's trading cash for bonds.  It's like the US economy is getting money out of the ATM, but here the Fed is forcing people to go to the ATM.

The effect that QE has is that it puts a lot, A LOT (hundreds of billions of dollars) of cash into the portfolios of organizations that usually hold treasury bonds.  Now that they have cash, they have to go invest that money elsewhere.  Typically that money goes into the stock market, the commodities market, and also the corporate bond market.  I haven't studied the data, but a common view is that the stock market tends to go up on heavy POMO (Permanent Open Market Operation) (i.e. Fed buying) days.

QE has had a number of interesting effects on the markets.  Some good and some potentially bad:


Possibly Good:

• More cash in the system helps to push up asset prices.  This partially offsets the billions of dollars lost from the system because of the housing crash and subsequent loss of incomes during the "great recession."
• Having an additional buyer in the treasury markets helps to keep bond prices up and interest rates down.  This is the functional way that the Fed is able to lower interest rates, even though they are at 0% already.
• It allows the US to stay artificially under the debt cap. The Fed gives the interest it earns on US Bonds right back to the Treasury.  So that's more cash for the US Treasury, but it's a little circular and kind of false.

Possibly Bad:

• QE increases the already HUGE size of the Fed's balance sheet.  It was already bloated after all the TARP and bailout related actions in 2008.  QE1 & QE2 have actually made the Fed the #1 holder of US Treasury debt, even surpassing China.
• More money means higher prices.  Inflation is much better than deflation, but it is unclear if the Fed will be able to keep a handle on prices while nursing a sick economy with negative interest rates.
• Inflation hurts creditors and savers.  All those responsible people (or countries) out there with savings will see their debt repaid to them with money that is worth less (though not "worthless") 

I hope that tomorrow the Fed Chairman will indicate that plans for QE3 are in place and the program will begin sometime in the next month.  The more forward he is with details, the more positive impact he will have on the markets.  The worst case scenario is he says, "we aren't prepared to do it yet" or perhaps "we have no plans to engage in more POMO."  Then we will be looking a sea of red.  Of course, Bernake knows this.  So, I expect that the likely case is that is they are prepared and will begin some level of POMO, but not establish a set amount and time limit.  This should be enough to stabilize the broad markets...and send commodities higher.

I think he speaks at 2:15 tomorrow.   I would be long going into that meeting.

MONKEY BUSINESS: 

Buying:  FAS @ $12.50, ERX @ $40.20
Selling: VXX @ $34.70 ($23.55)
Holding: AGQ ($159.70)

Silver Seasonality

Here is a chart that shows the seasonality of silver from 1970 to 2007.  Maybe some additional support to the idea that silver is headed north from here.  It was a brutal end of the week for silver longs (like myself).

 

MONKEY BUSINESS:

Holding: AGQ ($159.70), VXX ($23.55)

What happens if the COMEX defaults?

First, a basic definition.  A COMEX default means that they will not be able to actually deliver enough silver to meet the obligations of contract holders are due on a given date.

The futures markets turn into actual products on the monthly delivery dates.  The interesting thing with silver (as previously discussed) is that there has been a steady decline in the amount of silver that COMEX has to meet settlement deliveries over the last two years.  We are coming down to the end of this journey.  A basic (though perhaps wrong) extrapolation of the line set us up to have zero silver available sometime in the fall.

At that point, I expect a combination of things to happen.

1) The price of silver will rise to entice holders of silver to sell their physical silver.  There is still plenty of "eligible" silver in the COMEX warehouses, but it is not "registered" and thus not available for sale.

2) In response to the rising price of silver, regulating bodies will step in to mitigate the rise.  This could take the form of margin hikes (CME in May 2011), forced cash settlements (LME in 2006), or an outright prohibition of purchasing silver futures(CFTC & CME in 1980).  They allowed only sell orders in response to the Hunt Brother's actions!

3)      People may begin to demand audits of silver ETFs (SLV) to find out if they actually have the silver that they claim.  I have no insight to whether they actually have that silver or not.  However, the action alone wold put downward pressure on the ETFs.  This would in turn, put downward pressure on the price of silver, because they are a major day-to-day participant in the silver market.

4)      Huge movements in the price of silver (up and down) as people try to figure a semi-orderly way out of the situation.

The Nickel default at the London Metals Exchange in 2006 is probably the strongest comparable case to our current situation.  However, there are number of themes from the Hunt Brother's actions of 1980 that may also provide clues to what will happen.  However, given the current fiscal crisis in Europe, the budgetary issues in the United States and the sustained and popular retail interest in precious metals, today's situation in silver seems broader (and bigger) than either of those other events.  This suggests that the price action will be stronger, but also the regulatory response will be larger as well.

In any case, I think it means that the price of silver goes higher…but how much higher (and with how much volatility) is very unclear.

You can find the daily updated number of outstanding contracts here:

http://www.cmegroup.com/trading/metals/precious/silver_quotes_settlements_futures.html

Also, the chart showing ounces of “registered” silver in the COMEX is available here:

http://www.24hgold.com/english/interactive_chart.aspx?title=COMEX%20WAREHOUSES%20REGISTERED%20SILVER&etfcode=COMEX%20WAREHOUSES%20REGISTERED&etfcodecom=SILVER

One contract is worth 5000 oz of silver.  As of this week, there are 27.72 MM ounces available.  That is only enough to settle 5,544 contracts.  There are still 28,081 contracts open for July.  So the potential for July default exists.  My guess is that we will scrape by in July.  Enough people will settle for cash and roll over their contracts to future months. However, there are still 40,990 contracts outstanding for September and that may be enough to break the camel’s back.

As of today, there 93,023 contracts outstanding for the months remaining in 2011.  Since there is only enough COMEX silver to satisfy 5,544 of them, we are in for interesting times.  If the simple rules of supply and demand actually hold, we will be looking at MUCH more expensive sliver by the end of the year.

How much higher is anyone's guess.

MONKEY BUSINESS: 

Buying:  VXX @ $23.55
Holding: AGQ ($159.70)

Would the US Really Default?

I for one thought that a US default was outside the range of realistic possibility.  For the last half a century, the United States has been the icon of economic strength and stability.  But it appears that the at least some people think it's a real possibility in the next year.

The chart above shows the price of a 1-year credit default swap on US Treasury Bills.  For those of you who don't understand credit default swaps, a quick primer:

A credit default swap is a an agreement between two parties, typically large institutions.  Retail investors can't (yet) participate in the CDS market.  The agreement is set so that at the end of the period if the underlying debt issuer has defaulted (declared bankruptcy or otherwise defaulted on their debt payments), then the buyer of the swap gets paid $100.  If there is no default, then the swap agreement comes to an end worthless.  At the beginning of the contract, the buyer of the swap pays an agreed upon amount to enter the transaction.  In many ways is is like "insurance" for a bond holder.  If the bond defaults, the CDS is a mechanism to make them whole again.  However, it's not bond specific, so it's not an exact hedge.  This chart says that a CDS on US Government Debt is currently trading at 32bps.  Which is 0.32% or 32 cents for a $100 bond.  While that may not sound like a lot -- we can see that is almost 200% higher than it was last week.

It's important to keep this in perspective.  A 1-year CDS for Greece are currently trading over at 22.37%.  So we aren't even in the same magnitude of numbers.  But that indicates to me that 25% or so what a country might be trading at if it's...insolvent, running a massive deficit, and has only a few months of cash left.  I'm a little surprised it's not higher than that.  The country is on the brink of default!  It must be the tenuous EU and ECB backing that keeps the price of Greek CDSs relatively low.

Regarding the US CDS rate, I wouldn't panic about this move from 10 bps to 32 bps.  However, it is interesting to see SOME possibility of US default being priced into the market.  I suspect that this is mostly an attempt to price in the political risk of the US Congress not raising the debt limit before August.  I honestly can't imagine the havoc in the capital markets if the debt ceiling isn't lifed and the US actually enters a default situation.  I just can't imagine it.  It would be chaos. I'm sure between now and then there will be plenty of people who are smarter than me will paint some pictures in the financial and popular press.  I would expect that the images will be vivid enough to get congress to raise the debt cap.  In either case, I would expect that the US CDS probably get more expensive in coming months with or without a raise in the debt ceiling.

MONKEY BUSINESS:

Holding: AGQ ($159.70)

A Shrinking Inventory of Registered Silver

One of the more interesting pieces of the silver situation is the declining stocks of registered silver in the commodities warehouses around the world.

The prices of commodities on the commodity exchanges refer to the price of delivery of a specific amount of good on a specific date in the future (and at specific terms). For example the price of oil that is so frequently quoted in the news actually refers the price of one barrel of West Texas Crude delivered to the oil refineries in Cushing, Oklahoma. Unlike the stock market, the commodities markets actually have a physical good that is delivered at the end of the day. If you purchase a futures contract and don't sell it before expiration, you will take delivery of "stuff." Commercial users may actually want the coffee beans or corn, but most financial participants will simply take delivery of stuff via accounting entries in shared warehouses. However, sometimes a market participant will take physical delivery and request the product leaves shared warehouse.

For silver, there has been a shrinking supply of registered silver since 2007. "Registered" means that the silver meets all of the specific criteria to be deliverable and is also classified as such so that it can be transferred from one owner to another inside the warehouse (or can leave the warehouse).

The chart above shows the registered silver inventory at the COMEX until April 26, 2011. The most recent report (May 19) shows that the level of registered silver has fallen to 32.2 mm oz. Since silver futures trade in contracts of 5000 oz each, that means that the COMEX warehouse could only fulfill 6437 contracts if they stood for delivery today.

As of yesterday, the COMEX had 121,495 contracts outstanding. There were just a few still open for May and June. However, July shows 62,481 contracts still open. I don't know how many of these contracts will stand for delivery. In any case, using the most recent information, the COMEX would only be able to deliver enough silver to cover 10% of the outstanding contracts for July.

So, what happens if the COMEX doesn't have enough physical silver to meet the delivery requests? I don't know. I would expect it's partially a legal/contracts question and it's partially a market mechanics question.

From a purely theoretical standpoint, the silver market would adjust prices until an equilibrium is reached. Prices would head north until enough sellers decide that they don't really want their silver at the market price. Supply could come from new entrants or from silver owners who have eligible but un-registered silver already stored in the warehouse.

Another possibility is that the COMEX forces people to settle in cash rather than default. This seems like a likely path -- but then opens up the possibility that silver futures prices and physical silver prices diverge. This seems highly problematic for the exchanges and all the market participants. If your silver future doesn't really buy you silver, when what are you buying? This divergence seems to be a popular theme on the internet, but I don't think it's likely. There is too much reputational risk on the line for the exchanges to let this happen.

There are a lot of practicalities at play. It's unclear what will happen, but I expect that we will start to see it happen in the next few months. December has reasonably high level of open interest too. So if July doesn't give us resolution, it's likely that December will.

MONKEY BUSINESS:

Holding: AGQ ($159.70)

A Collapse in Silver

Over the six months, silver was a delight to own. That has changed in dramatic fashion over the last two weeks.

As you can see, the white metal has simply been pummeled since May 1, losing all of the value gained in the month of March in nearly a week.

So the question at hand is whether or not this is a temporary setback, or whether this is the official popping of the commodities bubble.

I believe that the scale of this decline is quite important. They say that sometimes things "take the stairs up and the elevators down." It certainly is the case here, several weeks of gains were wiped out in a single week. However, I think it's important to see that we did not loose a year of gains, but rather a month of gains.

In my opinion, this recent crash was simply the short squeeze from March & April coming to an and in grand fashion. I sold some in the run up, but should have sold more. Hindsight tells me I should have sold all of it, but as always hindsight was nowhere to be seen on May 1st. Thanks for nothing, hindsight.

This dramatic decline was encouraged by some extremely meaningful margin hikes by the CME. Margin requirements were nearly doubled in a week and this forced out a number of investors/speculators who were leveraged to the hilt. If the goal of the hikes was to lower the price, it was hugely effective as margin increase not only pushed out new positions but tripled or quadrupled the size of margin calls for anyone who initiated positions in the second half of April.

There is a lot to the story on silver. I will try and explain what I understand in future posts. But fundamentally, the two most important issues at hand are worldwide currency depreciation and the availability of physical silver.

Silver bounced off $33.00 pretty well this morning. Perhaps a bottom is in.

MONKEY BUSINESS:
Buying AGQ @ $159.70

Step 1

I've wanted to blog for a long time, but wasn't sure that I had the time or the dedication to make something that was worth while. But I figure that the first step is simply to start. If it sticks, it sticks.

The idea behind "The Market Monkey" is use a blog as a venue to share some of the lessons that I've learned an investor, banker, and student. I certainly don't have all the answers, but I've made and lost a few fortunes in the market over the last 20 years. Perhaps I can share some of my lessons with others, and help myself to remember to follow my own advice.

Step 1: Start a blog.