Much has been made in the financial press lately about the headwinds facing Groupon (NASDAQ:GRPN) as it transitions into a public company. I tend to agree with most of the skeptics about the excessive valuation ($13-14 billion even before any first day pop) and questionable growth prospects (there are only so many merchants you can convince to run a deal campaign).
It should be noted, however, that profitability should not really be on the list of investor concerns. It is true that for the first nine months of 2011 Groupon's operating income was negative to the tune of about $200 million, but to sign up as many email subscribers as possible, the company is spending an unsustainably high amount on marketing. So far this year, of $1.12 billion of net revenue, Groupon's marketing expense came in at more than $600 million, or 55% of sales, a number hardly ever seen outside of early stage start-ups.
If we assume that marketing expense retreats in coming periods to a more reasonable, but still high, level of 25% of revenue, we can see that Groupon can be very profitable almost overnight. In fact, at that level of marketing spend, the company would have netted more than $100 million in operating income for the first nine months of this year. As a result, while Groupon faces numerous hurdles going forward, those concerned that the business model is unprofitable (some have even called them insolvent) are focusing on wrong issues facing the company.