An Open Letter To Anyone Planning To Buy Into Groupon’s IPO

Dear Potential Investor,

I have mixed feelings about the Groupon IPO. On one hand, we’ve just come out of a horrible economic period where there was a real fear of wealth destruction. But now just a few months after the near-collapse of our financial institutions, we actually have an extraordinary opportunity for wealth creation — how great is that! On the other hand, there is no rational math that could possibly get anyone to the valuation Groupon thinks it deserves. Yes, Groupon grew from $30 million in sales to more than $700 million between 2009 and 2010, but most of that growth was artificial. (The lack of profitability is another issue, but let's not even go there.) Here’s why:

  • $265 million came from its international markets, which were acquisitions.
  • It spent a quarter-billion dollars (!) on marketing. To put that into context, the average large eCommerce retailer spends $11 million on interactive marketing. Back of the envelope calculations from the SEC filing get us to $31 spent to acquire a customer, who then probably spends a little more than that on Groupon. That means it spent about $250 million to make another $300 million.
  • It launched in more than 100 new markets in 2010. I’ll conjecture that in any market in America, you can sell $500,000 of half-off manicures and teeth whitening procedures in a year just by hanging a shingle. That gets us to another $50 million in revenue. 

In short, acquisitions, heavy marketing, and opening new “stores” (for which there are no markets left given that they’re now in Sioux Falls) get us to $615 million in revenues in 2010. That part of the so-called growth story is not sustainable. That leaves $96 million coming from truly organic growth in 2010. Now that’s not a shabby number given that its 2009 revenue was $30 million. But then that would mean its growth would only have been 233%  and not 2,200%. (What a boring story that would have been!). And that would mean that even at a multiple of 20x revenue, the valuation would be closer to $2 billion, a far cry from even Google’s valuation last December and much less than the numbers out there now.

Let me be clear, this is fundamentally a decent economic model — there are no expensive fixed costs, and the merchant bears the inventory risk.  Groupon won't go the way of Webvan. But the market opportunity isn’t as big as the industry players would like you to believe. That’s true for all the obvious reasons: It relies on discounting products, which attracts the wrong customers, merchants are hard to sell to, good merchants are more expensive to sell to, etc. This IPO game isn’t about finding value, it’s about finding a greater fool who actually believes the valuation is true. Trust me, you will be the fool. There will be plenty more IPOs coming up of companies with greater profitability and higher barriers to entry (e.g., social networks with hundreds of millions of followers). Those will be wiser investments. Give Groupon time to actually earn its valuation. 

Comments

Great comments Sucharita.

Great comments Sucharita. And this is about the "winner" (so far) of this deals space. Never mind the hundreds of clones who are attempting to copy Groupon bit for bit.

Standard investors should stay out of IPOs in general (it's an event for insiders and their friends) but perhaps doubly so here. I'd rather invest in LinkedIn even at high multiples. It's building a real business with serious network effects. Maybe one of the better stories since OpenTable IMO.

There will be quite a few

There will be quite a few folks, who get in once the public has access..wait for the price to go up over the course of the day while the general public buys its shares, and then get out the same day or the day after collecting the fastest money they will make.

Is Groupon different to LinkedIn, Facebook, Twitter and the rest

Great post, but is Groupon alone?

Hardly. LinkedIn briefly traded at over 30X annual revenues on the opening day of its IPO, and the paper evaluations of FaceBook et al are equally excessive.

A back-of-envelope calculation suggest that Facebook makes about $2 a year from each active account. Twitter makes less than 50 cents, and poor old MySpace was making something over $3 per account last year, according to public data ( see http://ianbruce.blogspot.com/2010/07/is-social-media-good-business.html ).

Hard to see how any of these businesses are sustainable at the evaluations being contemplated. And the advertising model, so successful with Google, may not replicate well with many of these social tools.

It's good to see Forrester sounding a word of caution. I can remember the last tech bubble and how Forrester and other analysts got on the wrong side of that. Thanks.

Valuations and coupon companies

Great post, Sucharita. I very much agree with you, and you didn't even need to explore the competitive world into which Groupon is securing itself to make your point! With more look-alike group-buying sites showing up and large players launching their competitive products, the margins are unsustainable. At the end of the day, it's an innovative coupon company, but how much are coupon companies worth?

By the way, I wrote my own screed on valuations and how social media professionals can protect their companies from the coming social media bubble burst at http://www.experiencetheblog.com/2011/06/prepare-for-coming-social-media.... Hope you enjoy it!

I fear a .com bubble is upon

I fear a .com bubble is upon us this time with a companies like Linkedin, Groupon, Facebook, etc... I wonder if people are buying the steak or the sizzle.

I dont see Warren Buffet running to buy up Groupon stock, so think twice, buy once.

Groupon – an old retail idea disguised as a new one.

Here was my comments when I heard about Google trying to purchase them:

I have been subscribing to Groupon for six months now and I am not impressed. I do like that they have enabled small regional businesses to have a channel to compete online with big businesses. What I find amazing is that the concept of loss leaders is not a new idea – nor is it a good one. Retailers funding 50% services that they would normally never discount that amount in an effort to gain new customers is not a sustainable strategy. Additionally paying Groupon 50% of the revenue from that promotion is a new all time high expense that once again over time will not be a sustainable strategy – so why all the hype? It is well know that attracting customers with deals that they will not see with any frequency is not reflective of who your business is. It also has no complexity so that all of your competitors can neutralize the promotion which only sets a new all time low value for your service. Last, the type of retailers that are using Groupon are specialty retailers who offer premium service at a premium price – so a loss leader strategy does not complement their value proposition. Time will prove this observation as true or false, but $6 B for a loss leader service provider sounds like a ridiculous amount of money in my opinion.

Anybody analyzed local retail data?

What are the local retailers who offer discounted services experiencing? Do they see an increase in traffic, return customers, word of mouth marketing through Groupon'd traffic? If those local retailers see no impact/no improvement in their foot traffic then Groupon and its look alikes are dead propositions; if however, there is a positive impact on their revenue, both short and long term, then I don't see why this could not be another avenue for local retailers to advertise their services and products and usher traffic into their stores. With the slow death of newspapers there are'nt too many mediums via which local shop owners can reach their customer base. Groupon is a great way to do so. Let's start with what the local retail data is telling us before we make a call on Groupon.

I still believe that there is

I still believe that there is a "real fear of wealth destruction" as you say in this posting, still possibly on the horizon. With the end of QE2 this month, it is anyone's guess how the markets will react. The worldwide economy picture is still very murky, with possible black swan scenerios seemingly present on every continent. Think Greece (Europe), Japan (Asia), U.S. (North America). Investing in a social company, does not seem like a wise investment at the moment with these tangible fears.

More reason to be worried about Groupon

Great analysis Sucharita. Reading through their S-1, there are some more startling revelations that should be pointed out. Out of the ~$1b they have raised, $850m have gone into secondaries with the company getting only $150m!! This is plain ridiculous. Founders cashing out so big and so early should ring the warning bells. Now they want to go IPO to get the much needed cash because they continue to burn money at an alarming rate with profitability not in sight yet..

1999 All over again

Loved this piece and then bumped around the net to find this
http://www.nochargeseo.com/dot-com-bubble-2-0%E2%80%A6/

I'd say, the promoters would make a lot of money diluting their stake via the IPO in case it goes through. I'm buying a yacht and small plane company if I have a billion dollars but not a tech coy !