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Even Google can't cripple this digital coupon king

Coupons ain't dead—they're digital. And now investors have a chance to cash in on the trend.

Americans continue to love a deal, even if they do more of their shopping online. Some 103.5 million adults redeemed digital coupons last year, a 12 percent increase from 2012, according to eMarketer. Usage is expected to continue growing apace until at least 2016, when the research firm projects 124 million adults will use digital coupons.

At the center of the action is RetailMeNot, a company that got its start as a place where bargain hunters could share coupons and discount codes. While about a third of the deals on the site are still submitted by users, RMN has negotiated agreements with thousands of retailers that supply their own coupons to its site. When shoppers click on an RMN deal and wind up making purchases, those partner retailers give the company a cut of the sale. RMN is by far the largest site of its kind, with $3.5 billion in total transactions in 2013, a 46 percent rise from the year before.

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Adam Jeffery | CNBC

Still, RMN has its challenges. The company depends heavily on Google, with about 65 percent of its customers reaching the site via a search engine. For example, a search for "J. Crew promo code" will return a list of results including RetailMeNot.com in the top spot. While search is important, it can be problematic because RMN is effectively at the mercy of Google's algorithms, which the Internet behemoth tends to change.

Google did just that several weeks ago, when RMN suddenly appeared lower down in the list of many search result lists. The good news is that RMN tends to gravitate back toward the top of search result lists fairly quickly. Two weeks after the algorithm change, RMN had recovered it first place search ranking in 70 percent of the cases where it had lost the top spot, the company said.

Even so, investors have punished the stock, which has fallen more than 40 percent from its peak in February. At today's level, the stock trades at 11 times 2015 consensus earnings before interest, taxes, depreciation and amortization. That compares with multiples of 47 times for review site Yelp and 24 times for travel site TripAdvisor.

That valuation discount looks steep given RMN's dominant position in the market. One advantage the company will likely keep is its vast supply of user-generated coupons and codes, which come in at a rate of about 200,000 per month. Even a deep-pocketed competitor would probably need years to build such a network of loyal users.

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RMN doesn't actually generate revenue from coupons unless it has established a relationship with the corresponding retailer. Yet, such an open approach allows the site to continue attracting the best deals, and as retailers recognize RMN as a source of customer traffic, they tend to form partnerships.

Indeed, RMN has direct relationships with 10,000 retailers who give it a cut of sales that originates on its site. Many of those retailers have actually given RMN special deals that aren't available elsewhere. Such exclusive deals appear to be highly effective: They account for about 1 to 2 percent of content on the site, but more than 5 percent of RMN's revenue, the company said.

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RMN also stands to profit from mobile e-commerce, where growth is surging. Some 43 million adults used coupons or codes they obtained on smartphones in 2013, a 43 percent rise from 2013, according to eMarketer.

RMN has invested heavily in its mobile app, which has already been downloaded onto 16.3 million devices. One strategy that should pay off over time is so-called geofencing, where RMN identifies a user's location and notifies him or her of deals available at nearby shopping areas.

It's true that retailers themselves often have apps that offer deals. But consumers will probably prefer not to have so much clutter on their phones. According to an investor note, Goldman Sachs research suggests consumers will prefer to choose just one or two coupon apps on their smartphones.

The most serious risk to RMN may be if Google tries to get in on the game itself. RMN offers a real marketing gem to retailers since they only pay for transactions that go through. But given RMN's headway into mobile apps where it's shielded from Google, there's reason to believe it will be a survivor. With the stock at a depressed level, it's looking like a deal that investors shouldn't turn down.

—By CNBC's John Jannarone

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