It's hard to feel any sympathy for Groupon's underwriters:
The Missed Red Flags on Groupon
By ANDREW ROSS SORKIN
DealBook
New York
October 17, 2011, 9:35 pm
This summer, Lloyd Blankfein, the chief executive of Goldman Sachs, flew to Chicago to personally pitch his firm to underwrite what was supposed to be the hottest initial public offering of the year: Groupon, the fledgling online coupon company that was being valued at around $30 billion.
Mr. Blankfein’s pitch succeeded and Goldman was selected as one of three lead underwriters, including Morgan Stanley and Credit Suisse. As the summer progressed, some insiders whispered that the offering could value the company at even more. For Wall Street, the I.P.O. was the ultimate bragging right.
They probably aren’t bragging anymore.
Groupon’s triple-digit growth has slowed, slicing Groupon’s valuation in half — if not more. Analysts now suggest the valuation will be lucky to be more than $10 billion. A series of accounting and disclosure gaffes have brought the attention of the Securities and Exchange Commission, raising questions about the company’s credibility.
The history of Groupon’s chairman, Eric Lefkofsky, was also unearthed, showing a lawsuit-prone entrepreneur who flipped a dot-com company in 1999 only to have it lead to bankruptcy a year later for the firm he had sold it to. And Groupon’s filing shows that when the company privately raised $950 million in a pre-I.P.O. round in January, it paid out $810 million of that to its investors and employees, a red flag for any investor. (Mr. Lefkofsky and his wife took home about $319 million of the total.)
All of this raises an obvious question: How did so many Wall Street firms desperate to underwrite the Groupon I.P.O. miss these warning signs when pitching such a sky-high valuation? Or did they just turn a blind eye?
“Underwriters are supposed to be gatekeepers, not just a sales and marketing agent,” said Lynn E. Turner, a former chief accountant for the S.E.C. “Underwriters have gotten to the point of being cheerleaders. I question whether they are really fulfilling their obligation to investors.”
A cursory reading of the various versions of Groupon’s prospectus that the banks signed off on, as did the accounting firm Ernst & Young, would give virtually anyone a modicum of pause. And a deep dive into the numbers should have raised alarm bells at the outset about even talking about the possibility of a $30 billion valuation.
Here’s just one data point: Groupon has $225 million in the bank. The company lost $102.7 million in the last quarter on revenue of $878 million. If that were to continue at the same pace, it would need to find a new way to start making money quickly or raise new financing. That is why the I.P.O. could not come soon enough. (Groupon, it should be noted, says it does not intend to use the proceeds of the I.P.O. to finance operations in the next 12 months. But there is always next year.)
In total, as of last quarter, the company had $681 million in current liabilities but only $376 million in assets. Among its liabilities, it owed $392 million to vendors. That is because the company receives money from customers before it has to pay its vendors, called a working capital deficit.
In some cases, a working capital deficit is not a problem. Wal-Mart has a working capital deficit, too. But when there are questions about whether your business can continue to grow at the same rate, a working capital deficit can become a problem because it means you are relying on a steady stream of new revenue to pay off old liabilities.
The company also spent $432 million in the first six months of the year on marketing, an unsustainable model. Add in the fact that Groupon’s revenue slowed in August, up only 13 percent, compared with 96 percent in the first half of the year, according to Yipit Data, and the picture becomes a bit nerve-racking.
Groupon is in a quiet period ahead of its I.P.O., so the company, as well as its underwriters, is unable to comment publically.
But in a memorandum to employees last month, Groupon’s chief executive and founder, Andrew Mason, said he was not worried: “We’re almost on the other side, and the negativity leaves us well positioned to exceed expectations with an I.P.O. baby that, having seen the ultrasound, I can promise you is not one of those uglies.”
He also said that he planned to slow the company’s marketing expenditures. “Eventually, we’ll ramp down marketing just as fast as we ramped it up, reducing the customer acquisition part of our marketing expenses,” he wrote.
Of course, it is possible that Groupon could update its prospectus with new numbers before the I.P.O., showing that it has already begun to get its house in order. If it were to really slow its marketing spending, it is possible Groupon could turn a profit.
Even so, it does not fully explain how Groupon’s underwriters, whose endorsement of the company is supposed to be considered the Good Housekeeping Seal of Approval, originally came up with Groupon’s questionable $30 billion valuation.
Perhaps more troubling, those same banks allowed their client to publish one of its first filings with an accounting gimmick. It was a made up metric called Adjusted Consolidated Segment Operating Income that accounted for the company’s operating income but conveniently excluded several major expenses, including marketing and acquisition-related costs. That caught the eye of the S.E.C., and Groupon has since been forced to remove the accounting metric.
The cynical reason that the banks stood by Groupon and its accounting shenanigans is most likely the expected fees from the offering. Even if Groupon’s I.P.O. values the company at $10 billion instead of $30 billion, the banks will probably walk away with hundreds of millions of dollars.
“There’s a ton of money to be had,” Mr. Turner said. “That’s what’s driving this.”
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