Only two weeks ago, local-deal start-up Groupon was acclaimed as an unprecedented eCommerce success and its IPO was as hotly anticipated as Facebook‘s. Since then, however, Groupon’s S1-Filing disclosed a cumulated $540 million loss on a cumulated $1.4 billion Gross Transaction Value. Suddenly, all love for the eCommerce posterchild seems lost and every aspect of the business is slashed. I believe critics should have been wiser earlier and the investment bankers who hyped up Groupon are to blame.
“Do not let anybody put you on a pedestal because once people realize you’re just human, it’s you that they destroy, not the image they created”. Groupon’s CEO Andrew Mason should probably meditate this thought from German author Bertolt Brecht.
Andrew Mason and Groupon, the company he co-founded in 2008, became the talk of the town after the company raised $135 million in April 2010 and, even more so, after it raised a whopping $950 million in January this year. With over 80 million online subscribers in more than 40 countries, Groupon dominates the booming local deal market it has contributed to create. Until recently, most observers were in awe. To name but one example of the Groupon-groupies: Last August Groupon was described by Forbes as the “fastest-growing company in Web history” and “what the dot-com boom was supposed to be all about“.
Well, now it seems that Groupon is rather exactly was the dot-com bust was about: a completely inflated valuation. Since Groupon has released its S1-Filing and revealed a cumulated loss of $540 million, criticism is raining on every aspect of the business. Worse, the critics are among the most influential voices in finance and eCommerce: Bloomberg, The Street, Marketwatch, The Economist, the FT, the Wall Street Journal, thisismoney.co.uk, Huffington Post, TechCrunch and more.
Below I review the 5 most critical points why Groupon is overvalued: 1) Inflated revenue and income; 2) Lack of merchant and customer lock-in; 3) Bad deal for private IPO investors; 4) Leadership flaws; and, most importantly, 5) Lack of financial value multiplier
Inflated revenue and income
- Inflated revenue: Whereas marketplaces like eBay recognize only merchants’ commissions as revenue, Groupon recognizes the entire Gross Transaction Value, i.e. the total value of the coupons sold to consumer as its revenue. The share of revenue returned to the merchant when the coupon is redeemed is treated as cost of goods sold. This is partly justified in that Groupon cashes in the coupon value ahead of returning its 50% share to the merchant. But this definitely distorts the picture on revenue versus income and expenses.
- Inflated income: In order to report a positive income, Groupon pulled a creative accounting concept of “adjusted consolidated segment operating income (ACSOI)”. Groupon justifies reporting as operating income what is essentially income before marketing expenses by arguing that subscriber acquisition costs is a one-off investment, not an operating cost. This is blatantly ignoring that a subscriber is never finally “acquired” and, on the contrary, has a huge maintenance cost. It seems however that nobody bought into the ACSOI anyway.
Lack of merchant and customer lock-in
Groupon claims to serve over 80 million subscribers and 50,000 merchants. But how profitable, active and loyal are they?
- Merchant loyalty much lower than claimed. While Groupon claims that over 95% of merchants do repeat business with the company, a 2010 independent study by professor Utpal Dholakia found that more than 40% of merchants did not intend to do business with Groupon again.
- Not a great customer acquisition channel. Many observers, like the Huffington Post have reported horror stories of merchants forced to shut down because a Groupon deal attracted too many unprofitable customers. One could argue that Groupon can’t help a few merchants’ poor planning. But still, Groupon is not the acquisition channel it’s claimed to be. Many merchants report that Groupon’s deal hunters don’t visit again later as regular customers. Follow the above link to prof. Dholakia’s study for more detail.
- Less than 20% of subscribers are buyers. Out of the 83 million subscribers Groupon is reporting at the end Q1 2011, only 16 million or 19% bought a coupon in that quarter. This shows how difficult it is to keep the subscriber base engaged and active.
Bad deal for IPO private investors
Private investors who have no priviledged access to Groupon’s IPO should be wary of buying stock at the height of the first day.
- Low float could cause a bubble. According to thisismoney.co.uk Groupon intends to float only 3% of the company shares. This is very little. The scarcity of the offer will most probably artificially inflate the stock price which will then fall when institutional investors with priviledged IPO access offload some of their shares. This is what happened with LinkedIn and several other recent Internet IPOs. LinkedIn share price doubled on the first day and has fallen by more than 20% since its IPO. See The Wall Street Journal for a thorough analysis of post IPO price drops.
- Founders retain B-Shares with preferred voting rights. As stressed by TechCrunch the three co-founders Andrew Mason, Eric Lefkosky and Bradley Keywell are most likely to keep the majority of the B-shares they had shared among themselves.
- Controversy on founders having already ‘cashed out’. This controversy was triggered by the fact that Groupon used most of the proceeds of its F-Series to redeem stock from early investors including Mason ($18 million), Lefkosfky ($60 Million) and Kewell ($23 million). This stock was redeemed at little more than $5 a share (against $32 for the shares issued) which indicates that the primary intention was not to cash out but to reduce dilution. Still the controversy persists and cast a shadow on the founders.
Now that doubts were raised, critics are becoming very personal about Groupon’s leadership.
- Once blue-eyed Andrew Mason is belittled. TechCrunch presents an unflattering account of Groupon’s International operations and in particular of its failed entry into the Chinese market where Andrew Mason himself had to travel to fire the entire management.
- Lefkofsky is suspected of manipulation. CNNMoney and many other call into question the “The checkered past of Groupon’s chairman“, Eric Lefkofsky who “knows how to generate big revenue through even bigger losses, often to destructive effect” . Several businesses of this serial entrepreneur were overhyped for investors.
Lack of financial value multiplier
Last but not least. The company’s business model does not present any strong financial value multiplier. This is Groupon’s weakest point, in my opinion.
There was no need to wait for the SEC Filing to do the maths. Groupon bashing is in full swing as I am writing this. It makes me wonder why so many wise critics were not heard more clearly before. It’s a little late now to stop an IPO which should rather never have built such high expectations.
I’m not denying that Groupon was/is a good business:
- simple, hard-to-resist offers,
- first-entrant lead
- clever marketing,
- great PR,
- many and efficient feet on the street and other (phone, online) sales people,
- good customer support,
- a good brand
- and lots of other good stuff (mobile etc.)
But Groupon does not have any lever that would justify to set its valuation at more than a low single digit multiplier of sales. It has:
- no proprietary technology,
- no patent or other business IP,
- no competitors’ barrier to entry,
- no customer (merchants, consumers) switching costs,
- no network effects: the social component of Groupon is weak
- not even a pyramid sales scheme…
Groupon has been buying market share through marketing and sales expenditure. Its business model is more akin to that of body-shop that brings revenue in direct proportion of the costs it incurs than to that of an Internet company.