Hot Stocks: Don't Let Groupon Inc. Play You For a Fool

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Groupon Inc. will try to get you to jump on its initial public offering (IPO) by touting its extreme growth and its profit potential - but don't believe it.

Even though Chicago-based Groupon, an e-commerce player that offers daily discounts to subscribers via e-mail, has exploded since it entered the online coupon world in 2008, that growth is threatened by the company's competition and mounting losses.

"The market opportunity isn't as big as the industry players would like you to believe," Sucharita Mulpuru, an analyst with Forrester Research Inc. (Nasdaq: FORR) wrote in an open letter to investors considering Groupon. "This IPO game isn't about finding value, it's about finding a greater fool who actually believes the valuation is true. Trust me, you will be the fool."

Here's why buying into what Groupon's saying about its profitability is a foolish move.

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It definitely appears that Groupon is losing market share and will be hard-press…

Not Worth It

Groupon filed its Form S-1 registration statement with the U.S. Securities and Exchange Commission (SEC) on June 2, joining the recent wave of online companies going public. It will trade under the ticker "GRPN."

Groupon in its filing listed its value at $750 million, but some say it could raise as much as $3 billion, valuing the company at $30 billion. That's even more than the $27 billion debut of Google Inc. (Nasdaq: GOOG) in August 2004.

That's also five-times as high as the $6 billion takeover bid Google offered Groupon in December 2010 - a huge jump many analysts can't explain.

"There is no rational math that could possibly get anyone to the valuation Groupon thinks it deserves," said Mulpuru.

Groupon cites soaring growth as the reason for its high value.

Groupon boasts 83 million subscribers - a 54,505% increase from 152,000 in mid-2009.

Groupon's sales also have increased. The company doled out 28.1 million coupons in just the first quarter of 2011, compared to 30.3 million in all of 2010.

But many analysts believe Groupon's days of explosive growth are over.

"[S]uch growth just can't continue at that pace," said Wall Street Daily's Chief Investment Strategist and IPO expert Louis Basenese. "It's simply not possible given a limited market opportunity. And that's particularly true in this case, considering all the competition that's knocking on the door."

Groupon may have started the online coupon trend, but now hundreds of competitors have flooded the market. Web sites like LivingSocial.com, Dealfind.com and BuyWithMe.com attract subscribers from Groupon's market share.

There are already signs of a less-active subscriber base in the conversion ratios - a signal that some of Groupon's customers have already started to defect.

Of Groupon's 83 million subscribers, only 15.8 million have made a purchase. Comparing Groupon's sales to its subscriber gains means it only sold 34 Groupon deals per 100 subscribers, down from 69 deals per 100 subscribers in 2009.

And Groupon offers no competitive advantage to keep its subscribers from flocking to the competition.

"There's no proprietary technology, or cutting-edge innovation, or critical and exclusive relationships helping Groupon stand out from the crowd," said Basenese.

Indeed, there's no proof Groupon will maintain its top spot among determined competitors - despite how much it's spending to acquire and keep customers.

Sky-High Losses

Groupon scored revenue of $94 million in 2008, and that swelled to $713 million by 2010. Groupon's revenue hit $644.7 million in the first quarter of 2011.

But slicing away at Groupon's earnings are staggering losses and steep marketing expenses.

The company posted a loss of $456 million, or $2.66 a share, for 2010. That's up from $6.9 million in 2009 and $2.2 million in 2008. It lost $147 million, or 95 cents a share, in the first quarter this year.

Since 2008, losses total $540.2 million, which is not an easy number for investors to stomach.

"To lose this money? What's crazy about these numbers is that this should be a highly profitable model," said Forrester Research's Mulpuru. "This is fundamentally a decent economic model - there are no expensive fixed costs and the merchant bears the inventory risk."

Groupon is also spending a great deal on marketing. The company spent $263.2 million on advertising and subscriber e-mails in 2010, up from $4.5 million in 2009. Groupon's marketing costs hit $208.2 million in this year's first quarter. The company says the marketing budget will dwindle over time, along with the cost to maintain subscribers.

Groupon argues that its heavy spending on marketing is a one-time expense to secure a dominant market share ahead of competitors. Chief Executive Officer Andrew Mason wrote in the SEC filing that despite high losses, Groupon still has amazing profit potential - if investors have the patience and faith to stick around.

"In the past, we've made investments in growth that turned a healthy forecasted quarterly profit into a sizable loss," Mason wrote in Groupon's SEC filing. "When we see opportunities to invest in long-term growth, expect that we will pursue them regardless of certain short-term consequences. Expect us to make ambitious bets on our future that distract us from our current business. We cannot be certain that we will be able to attain or increase profitability on a quarterly or annual basis."

But analysts aren't so sure those "ambitious bets" will ever pay off.

"It's not yet clear what their longer-term margins will be or when they will be able to get to consistent profitability," A.B. Mendez, a research analyst at GreenCrest Capital Management LLC, told Bloomberg News.

Sit This One Out

Groupon hopes to capitalize on investors' eagerness to find the next big tech stock.

"They'll call it good timing; I'll call it greed," said Wall Street Daily's Basenese. "Management wants to tap into investor enthusiasm for tech IPOs while it's running high. Otherwise they risk leaving money on the table."

Most analysts agree that investors looking to cash in on the tech trend should wait for an opportunity other than Groupon.

"There will be plenty more IPOs coming up of companies with greater profitability and higher barriers to entry (e.g. social networks with hundreds of millions of followers)," said Forrester's Mulpuru. "Those will be wiser investments. Give Groupon time to actually earn its valuation."

Those slated to join the Internet IPO club in coming months include gaming site Zynga Game Network Inc., which could be valued as much as $10 billion, and social networker Twitter Inc. Then there's the one many are waiting for: Facebook Inc., which is expected to file by next year and could be valued as high as $80 billion.

Basenese suggested investors wait for a company that has a more solid plan for profits than does Groupon. Those who don't could end up making the same mistake many investors did during the dot-com bubble in 2000.

"Focus on revenue and profitability," said Basenese. "Research out of the University of Florida demonstrates companies with at least $50 million in sales (for the trailing twelve months - ttm) and profits at the time of an IPO tend to outperform in the after market. During the last tech-driven IPO craze in 1999, most IPOs did not possess those two characteristics. And no surprise, most ultimately flopped."

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