The impending Groupon disaster
On November 4th, 2011, Groupon stock began trading on the open market. This IPO had been eagerly anticipated because besides LinkedIn, the tech IPO environment had experienced a lengthy drought brought on by the recession. Additionally, it received an abundance of criticism for being overhyped and overvalued. Nonetheless, after rejecting a $6 billion buyout offer from Google in 2010, its offering valued the firm at over twice that figure.
For that reason, and in hindsight, Groupon ultimately made the right decision in rejecting Google’s offer, though to many people it didn’t seem so at the time, and it seemed like an awful lot of money for a company derided as a Ponzi scheme. Given its rapid growth, it’s difficult to derive a solid valuation figure, but as discussed in Are we in a Web 2.0 Bubble? Yes!, the initial hype will lead to significant volatility in the short-term, and prices will not represent the fair value of the firm. There will be money to be made on both the long and short sides, but any gains made in the first few weeks or months of trading mean nothing about long-term viability and are no reason for supporters to say “I told you so.” Once the initial buzz wears off, Groupon stands a good chance of collapse within a few years barring a drastic change of its business model or another buyout offer. Is it a Ponzi scheme as some have charged? Time will tell, but we’d have a tough time arguing against that claim. Here’s why:
The IPO was shrouded in controversy before it even took place: Reasons included suspect accounting methods and charges of violating the SEC’s quiet-period rules. These are only two examples, but are likely indicators of deeper problems.
It’s grown big, but is still bleeding cash: Groupon may be the fastest company growing ever, so one would naturally expect growing pains. Still, at some point that revenue growth needs to translate into profits, or at least break even. After such rapid early growth it will have to plateau at some point, and with a valuation in the tens of billions of dollars already, it only has so much farther to go. The same can be said about any fast-growing company, but at they have to be profitable to support lofty valuations. It’s probable that most people who were going to try Groupon have already heard of it, so its future growth prospects are limited.
Customers have a love-hate relationship with the company: Of course shoppers like Groupon – who doesn’t like 50% off coupons? But they’re not really customers; merchants and retailers are. And when they take a 75% hit on revenue (a 50% discount on the sale, half of which is paid back to Groupon), it’s hard to justify whatever publicity it brings in. It makes for a good deal, but not necessarily good business.
Barriers to entry are low: It’s easy to make 25 cents of revenue if you give away a dollar of product, so of course revenue growth has been brisk. But that easy money quickly spawned competitors in the form of LivingSocial, Google Offers, Facebook Deals, and others. It’s not an especially technologically- or capital-intensive business, so competition will remain fierce, and being the biggest or first in the industry won’t help much.
As we said, there’s money to be made if one is willing to gamble. But long term, its prospects look dim.