Groupon Model Not Sustainable
Groupon filed its S-1 registration statement last week with the SEC for the company's $750 million initial public offering. According to co-founder Andrew Mason, “After selling out on our original mission of saving the world to start hawking coupons, in order to live with ourselves, we vowed to make Groupon a service that people love using.” I'm not sure I know what this means but what I am sure of is these are not pearls of wisdom that would make me gravitate to a Groupon IPO, unless, of course I get in at the asking price (let's say $40 per share) and cash out in the first few days, at let's say $80.
The owners of Groupon saw what happened at LinkedIn two weeks ago and they want a piece of the action. After the LinkedIn IPO, I questioned whether we were headed for another market meltdown as social media companies look to go IPO, wait for a brief period of time, and then cash in while the getting is good. Let's look at what happened at LinkedIn in the two weeks since its IPO. LinkedIn shares were priced at $45 at the opening and the company raised $353 million. For the chosen few who got in at the ground floor (i.e., LinkedIn founders, investment banks, the well-heeled and well-connected), the gain was substantial as the IPO priced at $94.25 the end of the first day of trading, a 109 percent increase in wealth. Not a bad return on investment for one days' "work." The results weren't so rosy for retail investors that were allowed in at an opening price of $83, up 84 percent from its issue price, but LinkedIn closed at $79.70 on June 3. My conclusion is that LinkedIn appears to have been an overvalued IPO, and that is bad news for long-term investors who are desperately needed to create a sustainable stock market.
Back to Groupon. If you look at sales, the company's prospects are bright. Sales increased from $3.3 million in the second quarter of 2009 to $644.7 million in the first quarter of 2011, according to the S-1 filing, as compared to $713,4 million for all of 2010 and $30.47 for 2009. However, given the company is currently losing a staggering $117 million per quarter, despite revenues of $644 million, Groupon will be burning through its cash almost as soon as it hits the company's account.
Groupon has been emphasizing growth and the consolidation of its market position around the world. However, the company seems to have ignored the cost equation and created a model that is not sustainable in the long run. The company said it expects its “operating expenses will increase substantially in the foreseeable future as we continue to invest to increase our subscriber base, increase the number and variety of deals we offer each day, expand our marketing channels, expand our operations, hire additional employees and develop our technology platform.”
CEO Mason set the tone in his letter that kicks off the IPO filing where he indicates that Groupon is focused on growth, and measures its success by metrics such as free cash flow, gross profit (Groupon’s actual take from its customer transactions, which was $280 million in 2010) and a third yardstick that is quite a mouthful: Adjusted Consolidated Segment Operating Income (CSOI). Those kinds of non-standard financial metrics were all the rage in the late 1990s tech bubble. Groupon discloses in its S-1 that the CSOI measurement reports the company’s operating income excluding several major expenses, including marketing and acquisition-related costs. Going by the nonstandard metric, Groupon pulled in nearly $60.6 million last year, much higher than the $3.5 million it reported in 2009. And in the first quarter this year alone, the company reported $81.6 million in adjusted CSOI. Groupon writes in its filing that it believes that the metric measures its financial health, excluding future operating expenses and noncash charges.
Accounting according to Groupon is strange indeed. Michael J. De La Merced, writing in DealB%K, an online publication of the NY Times, points out that those operating expenditures are very real costs, notably its huge marketing budget. "The company spent $263.2 million in marketing last year, an astronomical leap over the $4.5 million it reported for 2009."
Groupon's future is tenuous at best. In the short term, Groupon will probably do well and may mimic Amazon's success. Amazon IPOed in 1997 when the company lost $27.6 million that year on net sales of $147.8 million. That's an 18% loss for Amazon compared to Groupon's, 18% loss. Coincidental? Amazon didn't report their first profit until Q4 2001. But, Amazon had the market all to itself at the beginning as it took Barnes & Noble quite a while to make its mark as an online book sales competitor. Groupon, on the other hand, already is facing competition from the likes of LivingSocial.
Some have said that we have a new paradigm for commercial and service organizations. They work for money that works, not for profit and loss where losses and debt burdens can do damage for no good reason at all. In other words if you buy Groupon stock after it goes IPO, let the buyer beware. While the company is now experiencing rapid revenue growth, its operating margins are declining as a result of: decreasing per customer revenue; increasing costs to acquire customers; and increasing sales costs to run deals with smaller merchants to personalize the experience.
Are LinkedIn and Groupon harbingers of things to come for Facebook and Twitter? Are we heading for a social media stock bubble that will make the rich, richer while the poor do not share in the wealth and the middle class continue to get squeezed. I believe we will continue the recent pattern in the U.S. where the chosen few cash out before the bubble burst and the rest of us are stuck holding the collapsed balloon.
Blog by Steven Mintz, aka Ethics Sage, June 7, 2011