Is Groupon (GRPN) an Emperor Without Any Clothes?

While most market followers thought that LinkedIn's (LNKD: Charts, News) hyped IPO in May was the first sign of a "social media bubble" in stocks, increasing evidence suggests that recent IPO Groupon (GRPN: Charts, News) may better fit that bill.

While LinkedIn is a genuinely lucrative business - the Facebook of job seekers - which is slowly but surely evolving into the modern age's replacement for the resume, Groupon is not. For those late to the game, Groupon is a group discount website, which activates participating retailers' coupons if enough users sign up. The company first made headlines earlier this year when it declined a $6 billion takeover offer from Google (GOOG: Charts, News).


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Google's offer captured the public's imagination, and investors started to speculate that the company was holding out to raise capital through its own IPO. The company indeed went public in November, with shares offered at $20, but macroeconomic factors kept investors away from speculative stocks, and shares slid to a low of $14.85 before bouncing back above $20. However, the stock is still below its first day closing price of $26.11. Like other social media stocks, Groupon is not operating on fundamental strength - it is still operating at a loss so metrics such as price-to-earnings are meaningless - but rather hype and promises of future growth. In fact, even LinkedIn proved that stocks can only defy technical gravity for so long - shares now trade in the low $60s, a far cry from the high of $109 it hit just five months ago. What does the future hold for Groupon, and is it worth the attention of investors?

Trouble was already brewing at Groupon prior to its IPO. Analysts claimed that the company was overstating its revenue by 140% prior to its IPO, and post-IPO its balance sheet didn't look any better. Firstly, the company has $290 million in assets ($208 million in cash) but has $520 million in liabilities, equaling $230 million in net debt. $290 million of its liabilities include "accrued merchant payables" - in other words, merchants who are still waiting to be repaid by Groupon - a process that can take a sluggish two months and radically distort the company's quarterly reports.

The company's past earnings and revenue reports are baffling as well. In the first quarter last year the company reported $8.5 million in earnings on $44.2 million in revenue with a profit margin of almost 20% - solid, respectable earnings on par with some larger name Internet companies. Unfortunately, for the remainder of the year, the management shifted its strategy, pursuing extremely high revenue growth while abandoning profitability. For the rest of 2010, Groupon reported $669 million in revenue on a net loss of $398 million. For fiscal 2011, Groupon ended the year with revenues of $644 million on a net loss of $102 million. These figures should be red flags for any long-term investor - the company is sacrificing profits and margins in favor of accumulating more cash, which it is steadily losing due to its unsustainable balance sheet. This desperation for revenue suggests that its bizarrely-timed IPO on a tiny float (only 4.7% shares have been thus sold to the public) is a desperate attempt to raise cash quickly. If the company ever decides to offer more shares in a secondary offering, then the dilution would be catastrophic for current shareholders.

That should lead investors to the next obvious question - what's all the cash for? Groupon is pumping all these funds into attracting new subscribers through a marketing blitz, at an approximate cost of $5.50 per subscriber. The company spent $466 million on marketing alone last year to increase its user base. While Groupon's user base of 115 million definitely looks good on paper, only 25% of those accounts have ever purchased coupons on the site. In addition, companies - especially small ones - are starting to grow disillusioned their dealings with Groupon, which not only delays payments by two months (as mentioned earlier) but also keeps over half of the revenue from the deal. This explains the 3% drop in its local deals revenue, which is reliant on the support of small businesses. Last but not least, the company's bread and butter of daily deals and group coupons has non-existent barriers against competitors. Google and eBay (EBAY: Charts, News), both of which have much more influence and pricing power than Groupon, have already started to mimic Groupon's business, which will inevitably start a pricing war with both consumers and retailers - a battle Groupon will find impossible to win.

Groupon's rapid growth will likely prove to be its downfall. The company grew from nothing to 8,000 employees in two short years, while spending over $100 million per quarter but staying $230 million in debt. In late March, both the company's COO, Margo Georgiadis, and CTO, Rob Solomon, resigned - a disturbing sign that coincides directly with the company's shift from a slow but steadily profitable company into a runaway train rich in revenue but lacking fiscal discipline or margin controls, and destined for a horrifyingly spectacular derailment.

Other News About GRPN
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Activision is poised for rapid growth as the economy improves.
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Sony finally slims down as it struggles to stay afloat.

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Published on Dec 27, 2011
By Leo Sun
Leo Sun
Leo Sun is a freelance finance writer and position trader. He focuses on a combination of value and momentum investing, with a strong interest in the trading philosophies of Warren Buffett and Peter Lynch. Leo also has experience writing articles to help small business owners acquire loans and manage their finances. He regularly contributes to the Stock of the Day analysis.

Copyrighted 2016. Content published with author's permission.

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