Groupon Revisited

I never purchased shares in Groupon as it was obviously overvalued at first, and as the price fell I became more skeptical of the ability of anyone to predict future cash flows with any margin of safety.

The accounting troubles were unfortunate — I think this was a result of bad internal controls combined with extremely aggressive private market owners pushing to sell out to the public at high prices.

As I mentioned in my first post about Groupon’s competitive advantages, I still think it is very possible to have barriers to entry in this business, and to maintain high market share. People who claimed that the market was too commoditized turned out to be wrong in the end: so far, Groupon and LivingSocial have roughly maintained their market shares.

WSJ: “Groupon’s Growth Slows”:

Groupon has faced a series of hiccups since going public, including financial revisions and questions from regulators, as well as concerns that consumers are tiring of the daily discounted offers that it provides from merchants.

I think the last reason was the real downfall — not competitive pressure. I admitted the concept was faddish in my first post but clearly overestimated the sustainability of the online “group coupon” model in terms of popularity (Groupon, LivingSocial, Travelzoo, etc.).

I think it was originally a great idea — and it will continue to be a good product for certain businesses and consumers. But the incredible growth of the idea was short-lived. It turned out the be the “Peak of Inflated Expectations” in the Gartner Hype Cycle:

The idea itself became a fad among consumers (myself included) and as time went on people became either bored or sick of the idea. Small businesses that used the service also found out quickly that issuing a mass amount of hugely discounted coupons isn’t right for every type of business. It works for some, but not all.

At a price of $2.82, current enterprise value is around $750 million or $1.3 billion if you include the float from merchants payable. Will this price turn out to be cheap in hindsight? I still think it’s too hard to tell. But it very well might be if Groupon can right-size its business and reach the “Plateau of Productivity”. There is a certain level of volume that makes sense for this model, they just need to find it without losing too much money along the way.

Underestimating the Groupon Model

As widely reported, Groupon filed their first S-1 today in preparation for an IPO. They’re raising $750 million on top of the $160 million they have already raised from angel & venture capital investors so far. The likely valuation range will be $20-25 billion (or possibly more after what happened with the LinkedIn IPO).

The hefty valuation, along with the youth of the company (2.5 years) and the reported operating loss may lead observers and the media to cry “bubble.” While I think that $25 billion is a very rich valuation and wouldn’t pay that amount if it went public today, I think people in general underestimate the potential of Groupon’s business model. In other words, they were probably right to turn down Google’s offer of $6 billion (even if they don’t cash out during the offering).

Before going into Groupon’s business model and competitive advantages, here’s a quick run down of some of their customer statistics from the S-1:

In the above equation, those 5 metrics are multiplied to arrive at Groupon’s net revenue amount (the amount Groupon gets to keep after giving merchants their cut). So in the first quarter they made $270 million before expenses.

First the market, then the moat

Before Groupon and all the other deal sites began, local businesses had many lackluster options for advertising their product. They could send coupons in the mail; pay for ads in a local newspaper; pay for outdoor advertising; or pay for online advertising via Google, local news sites, etc. Most of these options (Google less so) are what Seth Godin calls interruption marketing. They are made to interrupt what you are normally trying to do. And because of that, people usually don’t like them, and they have a very low hit-rate in acquiring customers. Continue reading “Underestimating the Groupon Model”