Finally, after weeks of non-stop speculation and anticipation, discount coupon juggernaut, Groupon has submitted its plan for an initial public offering. Last Thursday, the company filed to raise at least $750 million and trade under the ticker symbol GRPN.
Given the smashing success of LinkedIn’s (NYSE:LNKD) recent stock market debut (shares more than doubled in the first day of trading), I fully expect to see overwhelmingly bullish predictions about Groupon’s IPO. My feeling? Non-plussed. In fact, I refuse to be part of the hype.
The reason is simple: After reviewing Groupon’s preliminary prospectus, there’s definitely cause for concern. I know -- who invited Captain Buzzkill to the IPO party? But hear me out on this one and I’m sure you’ll agree. Or at the very least, you’ll know to proceed with caution, instead of buying blindly on IPO hype.
You Can’t Deny the Growth, But It Won’t Last
I’ll give Groupon credit for one thing: It exploited a classic first-mover advantage to the highest order. And in the process, the company has unlocked staggering growth. Since cranking up the deal machine in 2008, the company has managed to increase:
- Its subscriber base from 152,203 to 83.1 million – a 54,498% jump.
- The number of North American markets from five to 175. It’s now in 43 countries, too.
- The number of merchants from 212 to 56,781 – a 26,683% rise.
- Its sales from $3.3 million to $644.7 million – a 19,436% jump.
And although the company has yet to turn a profit, that’s still eye-popping growth that other companies would love to have. But the fuzzy feeling ends there. Such growth just can’t continue at that pace. 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…
The Competition Heats Up
In Groupon’s IPO prospectus, the company readily admits, “Our business is highly competitive. Competition presents an ongoing threat to the success of our business.”
Even more damning, it confesses that “no significant barriers to entry exist” for competitors.
Groupon doesn’t offer anything truly unique. Heck, it doesn’t even offer a product. It simply partners with merchants to offer discounts to consumers and, in return, it gets a cut of the action. But anyone with an Internet connection, an email list and a willing merchant can offer the same thing.
And when Groupon touts its competitive advantages, it ironically underscores this glaring weakness in the process. It lists “customer experience and relevance of deals," “merchant scale and quality," and “brand” as its differentiating factors.
Take a close look at that list again. None represent sustainable business advantages. There are no proprietary technology, or cutting-edge innovation, or critical and exclusive relationships helping Groupon stand out from the crowd.
Sure, the company boasts one confirmed patent and five pending patents. But none promise to box out the competition. At best, they’ll allow Groupon to operate more efficiently. After all, you can’t patent offering coupons online.
Add it all up and it’s no surprise that the number of competitors is exploding. In fact, just from my quick count this morning, Groupon’s gone from being the only coupon kid on the Internet in 2008 to one of about 300 today. Current competitors – both domestic and international – now include Living Social, GoogleOffers, BuyWithMe, Ideeli, AmazonLocal (NASDAQ:AMZN), eBay (NASDAQ:EBAY), DealCatcher, and Daily Ticket. The list goes on and on.
Let the Price Wars Begin
With so much competition, it’s only a matter of time before “price wars” begin. By that, I mean Groupon’s rivals are bound to begin offering better terms to merchants in order to steal market share. This is just simple business strategy. (For example, Toshiba (OTCPK:TOSBF) just priced its Thrive tablet PC, due for release on July 10, below Apple’s (NASDAQ:AAPL) iPad 2.)
Remember, the way these online deal companies make money is by retaining a piece of the deals they sell. And if you’re a merchant, you want to keep the most money possible.
So let’s say a Groupon competitor offers to give a merchant 70% of the revenue generated, versus the 50% revenue-sharing agreement that Groupon reportedly offers. Who do you think the merchant will do business with? It’s a no-brainer.
Yes, other considerations – list size and average revenue generated per deal – are bound to factor into a merchant’s decision. But over time, as competitors grow in size, those considerations become less significant. And in the end, Groupon won’t be able to resist the price war.
Essentially, the online coupon market is destined to become a commodity market. And as Groupon reveals, increased competition could “reduce our market share and adversely impact our gross margin.” In other words, the company’s gross margins are likely to decrease, not increase, from here on. And that promises to put significant pressure on profitability.
Hardly an attractive business model. And the bloated numbers are concerning, too.
Pie-in-the-Sky Numbers and Negative Insider Moves
Not long ago, Google (NASDAQ:GOOG) reportedly tried to buy Groupon for about $5.3 billion. Fast forward a mere six months and now Groupon could be worth up to $30 billion. Sound the alarm bell.
Google wasn’t even worth that much when it went public back in August 2004. It debuted at a market value of $27 billion. And Groupon is certainly no Google. Not to mention, no matter how quickly Groupon is growing, nothing justifies an almost five-fold increase in market value in that short period of time.
Equally concerning is the action of Groupon insiders. The IPO filing reveals that it's been cashing out via dividends on preferred stock and redemption of preferred stock for years, to the tune of $60 million. It’s not clear how much stock insiders will be selling via the IPO, as it’s not listed in the preliminary prospectus. But that’s definitely a number you want to monitor as Groupon races to go public and files updated IPO terms.
If insiders end up selling a sizeable stake in the IPO, that’s hardly a bullish sign for individual investors.
Don’t Believe the Hype
Bottom line: I’m not saying Groupon’s IPO is destined to fail. Hype is a powerful market force and the stock could very well jump out of the gate, just like LinkedIn did. But remember, IPO hype fades quickly, as it did for LinkedIn.
If you bought shares of that “must-have” IPO on its first day of trading, you’re nursing losses of about 36% right now. So if you’re thinking about buying Groupon shares on their first day, think twice, as the move could prove similarly disappointing.
That said, if you can get shares from your broker at the initial IPO price, take them. You’re unlikely to get more than 100 shares, of course. But there’s no reason to turn down an easy profit. Just don’t hang on to shares, as Groupon doesn’t boast a business model that makes for an attractive long-term investment. And I’m even more convinced of that, based on the company’s current valuation and the actions of insiders.