Is Groupon Another

| About: Groupon, Inc. (GRPN)

There's crazy and then there's really crazy.

If you're buying Groupon's IPO you're in the latter camp.

Bloomberg claims:

“In terms of its progress toward a profitable enterprise, I think that’s a huge stretch,” Sorrentino said of the comparison between the two companies. For Groupon, “the beast is growing faster than its revenue stream, and you may be chasing profitability for a while.”

A while?

Try forever on for size.

Groupon (NASDAQ:GRPN), for the uninitiated, sells "Groupons" which are online coupons for a given service or product. The retailer "sells" them to Groupon (sorta) and Groupon "retails" them. You, as a consumer, buy them as the end user.

So who wins and who loses here?

Like paper coupons a Groupon has a "use by" date. They're attempting to leverage social media to "widely distribute" the Groupons to consumers, and for this they get a piece of the action. The merchant effectively pays a "vig" to Groupon for running the distribution system and collecting the money; once a Groupon is redeemed the merchant gets the paid price less a discount.

From the consumer's point of view these are more like a prepaid purchase of some good or service. Let's say the deal is "50% off" and the price is $20. The "regular sticker price" is $40 in your store.

You, the merchant, are selling a "regular" $40 product or service for $20. But in fact it's not $20; Groupon takes a piece of the "sale price" of $20 as well, so you might receive $18. And you receive it late: The consumer buys the Groupon from Groupon. This goes to Groupon's balance sheet as "cash" and the payment to the merchant is an accrued liability. The merchant gets paid only when the groupons are redeemed.

Essentially Groupon "lives" on the float. And that float, if you look at the S-1, is getting bigger as a percentage as the company has grown. That is, in my opinion, bad, because it means the firm is surviving on two things, neither of which is likely to continue:

  • Non-redemption. That is, the consumer buys and then doesn't use. This is "free money" for Groupon but it came out of the consumer's pocket. It is unlikely to continue to do so, and the higher price of the service or good the more-likely the coupon is to be redeemed.
  • Delays in payment. Groupon "aggregates" these coupons and pays merchants when the aggregation reaches a given level. They have the use of the money in the meantime. That's nice for them, not so nice for the merchant who just delivered a good or service they didn't get paid for in the present tense! Realize that the merchant's usual operations either pay him immediately (cash) or the next day (credit card settlement.) Now he's taking duration risk and he's also an unsecured creditor of Groupon yet the good or service was delivered to the customer!

I don't like this one bit as a prospective merchant - especially the second. I sell at a discount, presumably at or near a loss, and then have to wait to get paid too? How does this work? Well, it might, but that would depend on two things:

  1. Can you profitably sell at the discounted price less expenses? Usually the answer is "no."
  2. Does the customer come back and buy again at full price? If not, you lose big: You not only lose on the original transaction but your "customer good-will building" was for nothing, as the consumer buys once and doesn't return at the full price. And it was that second part - "on the come", for which Groupon is not responsible - that makes the deal work.

What do I think of the model? I think it sucks.

As a consumer I'll buy a $20 pizza for $10 (one of the deals being offered right now in my area.) But the entire reason I'll go to that pizza place is that the pizza is $10 -- at $20 I'm not a customer!

In this particular case the merchant gets nothing for their trouble except a guaranteed loss and delayed payment! It's not a "loss leader" as I won't come back without the discount, it's a loss maker.

How prevalent is my view on this? That's the problem - nobody knows. But it's the key to the entire scheme, because what I see when I look at Groupon is a lot of 40, 50, 60% discounts - which sound ok but are big enough discounts that they're likely to attract people who will buy only because of the deal. As soon as the deal disappears so does the customer.

I don't see the business case for this company as I don't see the sell-through on a consistent, forward basis. Consumers will always take something for free: The store willing to give away steak will give away every piece of it they have! That's not the question: Will the people then come back and pay full price for the second slab of meat?

I think the answer is "no", and if I'm right on that then the actual value of the Groupon service is zero, and thus their stock is also a zero.

It's just a matter of time.

Disclosure: Oh, what a tasty morsel of a short this looks to be..... Netflix on steroids!