The Groupon Rorschach TestDuncan Davidson - Monday, June 20th, 2011

Valley People poured over the Groupon IPO filing like the NYT over Palin emails, looking for clues. They saw what they wanted to see. It ranged from “Ponzi Scheme!” and “Swindle!” to the ironically witless “no, it’s like Amazon and other dot-coms.” They meant to justify Groupon because Amazon ran years of losses before become a great franchise; but they instead raised the spectre of the “B Word”: a dot-com bubble stock.

Of course, Groupon is not really like Amazon: while it has much more revenue ($700M vs. $16M), a bigger user base (50M vs 35M), raised a boatload more capital ($750M vs. $55M) and a much higher expected IPO valuation (see table), it also has a much bigger loss: $400M on $700M of revenue. It not financing inventory risk but customer acquisition, a less tangible outcome than Amazon. And when Zynga goes out, it may show a gain of $400M on slightly higher revenue. Which deal would you rather own?


Also, those stunning reported revenues are gross numbers for the coupon that overstate the net revenues that they keep, which run less than half the reported. Other companies, including pas-through marketplaces like eBay and Amazon Marketplace, report the net numbers. The Groupon approach, of reporting the gross coupon not the net, can be gamed: increase the coupon and the discount, for the same net value to Groupon but much higher revenues. Investors beware.


Fortune piled on, highlighting the checkered career of the Groupon chairman, concluding his style tends towards “… rapid revenue growth accompanied by big losses, a penchant to sell stock early on, and lawsuits filed by investors, lenders or customers who feel they have been wronged.” Whoa! They go on to compare him with Amazon’s Jeff Bezos, whom they say has “a brilliant instinct for navigating risk.” Ouch!


Reporters began digging up stories of disgruntled merchants. The merchant agreement was ripped apart, arguing it is a poor deal for most merchants, resulting in a high churn rate for Groupon and a very low customer-retention rate for the hapless merchants.


Worse, a look at the back of the S-1 shows that the insiders took a lot off the table in the last two rounds, as much as 90%. if the insiders do not believe, why should a public investor?


Seemed all over for Groupon! By mid-week reporters were running stories about how bored they were with Groupon stories. They thought they knew how it would end: dot-com valuation, tons of losses, sketchy management, inflated revenues, disgruntled merchants, and insiders bailing. But they didn’t read the fine print.


One of the bubble-era kingpins, Henry Blodget, did. He pointed out what all the Groupon haters had missed: it is cash flow positive. It collects the full amount for the coupon up front, and only remits to portion back to the merchant when the coupon is cashed. It actually generated $72M of positive cash flow last year while losing $413M on its income statement.


Lost in the noise was a positive report by Yipit, which is an aggregator of daily deals from places like Groupon (and yes, has an interest to keep Groupon happy), which concluded that merchants are much happier with Groupon than the stories above would lead one to believe. They found that 44% of merchants in May had re-upped for daily deals. Groupon does best with service businesses whose problem is yield management – they have high fixed costs and low variable cost, so each marginal new customer is valuable.


Our take on this is best captured in a recent post on the Barbell Strategy: the death of the small tech IPO has resulted in much more value accreting to insider investors than in previous eras. The IPOs are going out at much higher values, and are likely leaving a lot less upside to the retail investor. When a pre-IPO company hits valuations typical of great IPOs in the past, it makes sense for the early investors to begin cashing out. They are in the business of riding from $5M to $5B of value, not $5B to $50B. So everyone just plain over-reacted to the Groupon S-1 and insider selling. Groupon is an enormous force right now, transforming local merchant marketing, and spawning daily-deal copycats globally. Unlike the dot-coms, it is generating enormous growth and revenues, whether counted gross or net. This is not the stock that pops the social-mobile bubble.


This article appears as part of a content sharing arrangement with Bullpen Capital.



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