Once Public, Groupon Could Get Clipped
By TIERNAN RAY /
Barron's Technology Trader | SATURDAY, JUNE 4, 2011
The coupon giant could prove to be a huge disappointment after its planned IPO.
The suddenly crowded market for Internet startups with implausible dreams welcomed a large new arrival last week—Groupon, the high-tech coupon-clipping operation. It offers exactly what investors are clamoring for: astonishing revenue growth, even at the expense of profits.
Groupon, based in Chicago, filed for an initial public offering to raise $750 million, though the final take certainly will be much higher.
The company, founded in 2008, offers subscribers coupons via e-mail. These are "daily deals" for things such as half off the price of a spa visit, or a dinner at a local restaurant. Groupon turns the transaction into an "event" by requiring that a certain number of subscribers buy the deal within a specified time frame, or there will be no deal.
Groupon gets about 40% of the dollar value of the purchase price, on average, with the merchant taking the rest.
The growth of the company's business seems unreal: From $44 million in the first quarter of 2010, the top line has expanded 15-fold, to $645 million in the three months ended March. If you accept Groupon's "adjusted" pro-forma financials, which don't agree with generally accepted accounting principles, the company made $82 million in profit on that—a near seven-fold increase during the period, reflecting a profit margin of 13%.
Because of such growth, it is hard to say how the IPO will price. The shares have traded for months on secondary, private stock exchanges, such as Sharespost.
With roughly 300 million shares outstanding, at a recent privately-traded price of $35, the implied-market capitalization is about $10 billion. But whisper numbers have circulated putting the offering at two or three times that much.
Yes, it is conceivable this young company could go out of the gate with $30 billion in market value. Investors in such startups have been grumbling of late that their bankers are too quick to leave money on the table. LinkedIn (ticker:LNKD), for example, went public at $45 a few weeks ago and doubled in value on the first day of trading. Most of the value created went to friends of the bankers. So there's pressure now on underwriters to set the offering at a price more reflective of unlimited demand for Internet shares.
A lofty initial price could leave Groupon challenged to meet expectations. The company's implied revenue for this year, $2.6 billion, means that at $20 billion in market value, it would be worth eight times sales. Take taxes out of the $82 million in quarterly pro-forma profit I mentioned, and implied earnings for this year would be about $200 million. In other words, Groupon could have a price/earnings ratio of 100—expensive by any standard.
That math assumes little to no growth this year, which is probably not the case given the trajectory of the business. But to increase sales profitably will be difficult. The numbers I've cited so far are generous.
In actuality, on a GAAP accounting basis Groupon lost $146 million in the first quarter. The cost to sign up new subscribers, which is excluded from pro-forma results, rose more than revenue, increasing 45-fold year over year, to $180 million in the first quarter.
AS WE LEARNED IN THE DOT-COM days of the late 1990s, it takes a lot of money to build an online business. The subscription costs are apt to keep piling up.
The folks at Groupon want you to forget those losses and look at the adjusted numbers, because they insist that if they stopped spending money to market themselves, they could coast on the buyers and sellers they already have and milk the business for profits.
But the operating history of Groupon is so short, there's little evidence that's true. Absent from the IPO prospectus are key data, such as how many customers and merchants stick with the service and how many walk away. All that is offered are some "cumulative" numbers, such as 83 million subscribers, and 57,000 merchants.
Even if Groupon truly believes it can ratchet back on spending, the market might not let it. Investors are enamored these days of companies that spend and spend to capture what seem to be vast new markets. Just look at Amazon.com (AMZN), and Netflix (NFLX), both of which have said they will sacrifice profit to spend on "growing the business."
So, spend Groupon must. And, unless the business finds a way to build sales even faster, the official losses will continue to mount. A rich valuation for the IPO could become even more egregious in short order.
Which is why, perhaps, some insiders already have cashed in some of their chips. In January the company received a hefty $950 million round of investment, which valued Groupon at about $5 billion. As explained recently by Peter Kafka of AllThingsD, only $136 million of that money was used to fund the business. The rest was used to buy shares from CEO and founder Andrew Mason, investor Eric Lefkofsky, and others.
Why would the insiders settle for prices vastly below what an IPO might yield? Perhaps because they realized the valuation had already gotten well ahead of the business's actual results, or its potential. On paper, Mason and others will still end up billionaires if the IPO prices along the lines discussed. One thing is for sure: Those guys won't have to clip coupons to pay for the celebration dinner. |
