Groupon has filed its S-1 and hopes to raise $750M in its initial public offering. Given they’re currently losing a staggering $117M per quarter, despite revenues of $644M, they’ll be burning through that cash almost as soon as it hits their account.
At the moment, it’s costing them $1.43 to make $1, and it doesn’t look like it’s getting any cheaper. They’re already projected to make close to three billion dollars in revenues this year. If you can’t figure out how to make money on three billion in revenue, when exactly will the profit magic be found? Ten billion? Fifty billion?
With cash on fire like this, they surely need more. They recently took nearly a billion dollars from investors, but hardly any of it went into the business. Instead, the bulk was used to cash out insiders and early investors. What they’re left with is roughly $208M in cash on hand, which is less than two quarters worth of operating capital at the current burn rate.
The venture capitalists who jumped on board in January with a cool $950M in series G funding were obviously not going to repeat the deed. They’re merely in line to turn a quick buck in the forthcoming IPO pop. Imagine the dialogue: “Okay, here’s a billion dollars, but we fucking want it back this year — a couple times over!”
Since they saw the numbers on the business in January, they surely knew that Groupon was going to need a truckload more cash and soon. And since the round was already a who’s who from Sandhill Road (Greylock Partners, Kleiner Perkins, Andreessen Horowitz), the next step was naturally to dump it on the public.
Boulevard of broken deals
What’s so frustrating is that on paper, Groupon appears to be one of the best business ideas in the world. You convince small merchants to give extreme discounts to get access to more customers, and you get to keep half of the revenue yourself. No need for warehouses, distribution, or inventory. Add a recession-battered, coupon-hungry public and presto, the gold faucet is flowing!
If only. The S-1 tells us the reality is far from that ideal. Groupon had to spend $208M on marketing in the first quarter and another $178M on sales people and the rest. Surprise, surprise — it’s costly to buy enough ads to reach the volume of consumers needed to produce such staggering revenue numbers. Likewise, hiring an army of 7,000-and-counting employees to cold-call every small business owner in the world costs a pretty penny, too.
But, but, but what if they’re the next Amazon?
First, Amazon spent the billions that bled their balance sheet digging an incredible moat. They built warehouses and distribution centers, and had to keep every fucking item in the world in inventory. That turns out to be very expensive too, but repaid at scale.
Where’s Groupon’s moat? Sure, they have a list of 56,000 merchants who might do business with them again and 83 million email addresses of people who might buy another coupon. Do you really think that’s comparable to the infrastructure moat Amazon built?
And if that actually is their moat, why aren’t they bragging about how low their churn rate is? Their investment in cold-calling merchants will only pay off if most merchants stick around to do many more deals. The same goes for coupon shoppers. They need to be loyal enough to keep buying from Groupon without needing to be wooed over and over again with expensive ads.
Update: Analysis from one of Groupon’s oldest markets, Boston, show that there is no moat. Acquisition costs are skyrocketing and revenue per customer is plummeting.
Second, for every Amazon blessed with the good grace of the market to lose billions for years while proving their business model, there are ninety-nine WebVans, Pets.com, and other tombstones in the graveyard of profitless ventures. Losing billions for years is generally not a winning strategy, despite the odd exception.
The market gets what the market wants
Yet none of this is likely to matter. The market has already demonstrated its headless intent to pay silly multiples on the opening day of any new tech IPO, as the recent LinkedIn deal showed. It’s also been willing to pay unprofitable businesses like Salesforce handsomely for creative accounting schemes and blockbuster revenue numbers, profits be damned.
Morgan Stanley, Credit Suisse, and Goldman Sachs are putting their good names behind the Groupon deal and will sell into the all-but-assured bull-opening run. The people who will end up assuming all the extraordinary risk are the pension funds and regular schmucks now eyeing another chance to get in on the ground floor of another bubble.
Groupon is imitating Salesforce’s accounting magic
As if inspired by Mark Benioff’s accounting schenanigans in the latest Salesforce quarterly earnings report, Groupon’s management has come up with their own fantasy accounting metric. In a letter to prospective investors, Andrew Mason explains this wizardry as “Adjusted Consolidated Segment Operating Income” or “Adjusted CSOI.” He explains:
This metric is our consolidated segment operating income before our new subscriber acquisition costs and certain non-cash charges; we think of it as our operating profitability before marketing costs incurred for long-term growth.
I’ll let Eric Savitz from Forbes rip into this one:
The adjusted CSOI measure is the one I find a little disturbing. This measure backs out “online marketing expense, acquisition-related costs and stock-based compensation expense.” Not counting online marketing expense seems, uh, ridiculous. The company writes that “online marketing expense primarily represents the cost to acquire new subscribers and is dictated by the amount of growth we wish to pursue.”
Uh, ok, but look what happens if you don’t count it. In Q1, the company had a loss from operations of $117.15 million; that reflects $179.9 million in marketing expenses; back that out and – voila! – massively positive adjusted CSOI. Likewise, for all of 2010, a loss from operations of $420.3 million includes online marketing expenses of $241.5 million, and acquisition expenses of $203.3 million, plus stock-based compensation expenses of $36.2 million. Back all that out, and – tada! – positive adjusted CSOI.
The bottom line is that considering the profitability of Groupon without online marketing expenses is silly; Groupon without marketing expenses is not Groupon at all.
So I guess the new playbook says that whenever generally accepted accounting principles don’t produce the kind of headline numbers investors want to hear, just come up with your own numbers to fit the growth narrative. Hey, it worked for Mark when he announced Salesforce was switching to non-GAAP numbers that didn’t include stock compensation for sales people (a twist that ensured he and other execs would hit their targets and get their bonuses)…so why wouldn’t it work for Groupon?
You can fool some of the people some of the time, but you can’t fool all of the people all of the time.
Groupon has a great tagline in “the fastest growing company in history,” but don’t underestimate how incredibly risky an investment it still is. There’s a very real chance Groupon will never figure out how to tune the revenue machine enough to produce even a penny of profit. They’re asking the public to value them at an alleged $25 billion (or 1/12th of AAPL, a company that generated $6 billion in real profits last quarter) on a hope, a prayer, a song, and a dance about fantasy metrics.