Groupon IPO: not all that rosy beneath the extreme growth rates

Groupon, the daily deals site, has now filed to go public to raise $750m. Here is the section 'Business' from the SEC-filing:

Groupon is a local e-commerce marketplace that connects merchants to consumers by offering goods and services at a discount. Traditionally, local merchants have tried to reach consumers and generate sales through a variety of methods, including the yellow pages, direct mail, newspaper, radio, television and online advertisements, promotions and the occasional guy dancing on a street corner in a gorilla suit. By bringing the brick and mortar world of local commerce onto the internet, Groupon is creating a new way for local merchants to attract customers and sell goods and services. We provide consumers with savings and help them discover what to do, eat, see and buy in the places where they live and work.

We started Groupon in November 2008 and believe the growth of our business demonstrates the power of our solution and the size of our market opportunity:

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We increased our revenue from $3.3 million in the second quarter of 2009 to $644.7 million in the first quarter of 2011.


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We expanded from five North American markets as of June 30, 2009 to 175 North American markets and 43 countries as of March 31, 2011.


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We increased our subscriber base from 152,203 as of June 30, 2009 to 83.1 million as of March 31, 2011.


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We increased the number of merchants featured in our marketplace from 212 in the second quarter of 2009 to 56,781 in the first quarter of 2011.


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We sold 116,231 Groupons in the second quarter of 2009 compared to 28.1 million Groupons in the first quarter of 2011.


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We grew from 37 employees as of June 30, 2009 to 7,107 employees as of March 31, 2011.

Each day we email our subscribers discounted offers for goods and services that are targeted by location and personal preferences. Consumers also access our deals directly through our websites and mobile applications. A typical deal might offer a $20 Groupon that can be redeemed for $40 in value at a restaurant, spa, yoga studio, car wash or other local merchant. Customers purchase Groupons from us and redeem them with our merchants. Our revenue is the purchase price paid by the customer for the Groupon. Our gross profit is the amount of revenue we retain after paying an agreed upon percentage of the purchase price to the featured merchant.

Groupon primarily addresses the worldwide local commerce markets in the leisure, recreation, foodservice and retail sectors. According to Euromonitor, the leisure, recreation and foodservice market is expected to be $1.4 trillion in the U.S. and $5.3 trillion internationally in 2011. The retail market is expected to be $2.9 trillion in the U.S. and $12.2 trillion internationally in 2011. We believe a substantial portion of these expenditures on leisure, recreation, foodservice and retail will be spent with local merchants. Groupon also addresses the online advertising market serving these merchants. The size of the U.S. online advertising market is estimated to be $51.9 billion in 2011, of which $16.1 billion is estimated to be spent by local merchants according to Borrell Associates. The size of the global online advertising market is estimated to be approximately $79 billion in 2011, according to IDC.

First of all, two very important issues have to be kept in mind:

• Groupon grows mainly by acquisition (but it is unclear how much organic growth is). What we really need is a 'same stores sales' number.
• The entry barrier is very low. Loads of competition is coming, from a wide range of companies: LivingSocial, DailyCandy (Comcast), Woot.com (Amazon), Thrillist, ChoozOn, Google Offers, Facebook Deals, Spreets (Yahoo! in Australia), even AT&T/YP.com and lots of newspapers such as Treat Me in New Zealand and Times Limited from the NYT.

And here are some thoughts on the numbers:

• Growth by acquisition is hard to value. We have done a similar thing for Skype (for which Microsoft ended up paying much more than we anticipated) and LinkedIn (which was sharply undervalued at its IPO). For Groupon, we do not look at R&D (there is none), but marketing as an essential source of growth.
• In 11Q1, revenues were up 14x, gross result 14x, earnings after marketing 27x.
• Gross margin appears to be roughly stabilising at the 40-45% level. The earnings-after-marketing margin is not yet stabilising.
• In 11Q1, operating cash flow was up 39% and free cash flow was down 42% (possibly as a result of buying office space?). So, cash flow growth is not nearly keeping up with topline growth.
• In 11Q1, subscribers were up 24x, customers 18x, merchants 20x, groupons sold 16x.
• The activity rate (customers as a percentage of subscribers) seems to be sort of stabilising at around 20%. The number of groupons per customer is down to 1.78 from 2.01 last year. The number of groupons per merchant is also down, from 606 to 495.
• Conclusion #1: subscribers are growing faster than revenues, so are becoming less valuable.
• Conclusion #2: buying groupons per customer is down, so either competition is kicking in or the excitement of buying is wearing off.
• Conclusion #3: selling groupons per merchant is down, so either Groupon is adding less interesting (and interested) merchants, or they are less willing to offer their wares at steep discounts.
• Conclusion #4: operating cash flow as a percentage of revenues is not as impressive as one might expect; there was a peak level of 27% in 10Q1, but all of 2010 was just 10%. It is early days, but the business doesn't appear to be that profitable.

Now how about valuation? Again, we compare to Google, which currently has a $138bn enterprise value. Google's PEG-proxy (price/earnings to growth, hre: value/gross result to growth or value/earnings-after-R&D to growth) is somewhere between 0.30 and 0.50. Groupon has been rumoured to go for a valuation of $20-25bn, but that is hard to get at, using the Google multiples. See for yourself.