Groupon (GRPN) rode the black Friday weekend sales wave with 500% growth in holiday sales from last year. Investors who watched shares sink 50% from their IPO peak welcomed the news. But does the Groupon back story suggest investors should pick up shares?
In Q2, Groupon had gross billings of $909.2 million. But factor out the payments to vendors supplying the deals and sales drop to $392.6 million. While a $1.6 billion run rate is nothing to sneeze at, a $10 billion market cap still seems rich - particularly given the company's expected $700 million quarterly marketing budget. On top of that, over $400 million in 2010 losses and more coming down the pipeline should make even the most risk tolerant investor shudder.
Another cause for concern is management. I've spent the past few days reading SEC filings of other companies Groupon's founders have brought public, and I can't help but walk away uneasy.
Since Groupon's founding, venture capitalists have invested over a billion dollars. But a lot of that money, including nearly $400 million used to buy back shares from co-founder Eric Lefkofsky, was funneled back to early investors. Mr. Lefkofsky still owned a sizable 22% stake in Groupon heading into the IPO.
An article in Fortune back in June highlighted questions surrounding Mr. Lefkofsky, including finances related to his pre-Groupon venture InnerWorkings (INWK). Mr. Lefkofsky brought InnerWorkings public in 2006 at $9 and the stock peaked at $19 three months later.
Despite one attempt in 2008, InnerWorkings stock hasn't been close to that level again. It currently trades below $9. The IPO, however, was a big win for Mr. Lefkofsky who sold an additional five million shares in a follow on offering for $13.50 per share. Mr. Lefkofsky remains a major owner of the company through Orange Media LLC, whose sole member is Eric Lefkofsky's wife Elizabeth. At the end of last year, Orange Media LLC, along with Richard Heise, Jr, owned 21.6% of InnerWorkings stock.
InnerWorkings itself is heavily reliant on its biggest customers. The top ten represented 31% of sales in 2010. Non-sticky transactions accounted for nearly 30% of sales. Overall, more than 60% of InnerWorkings sales are tied to either big accounts or one-off transactions. Like Groupon, InnerWorkings is dependent on scale and at risk from client turnover in a hyper competitive market. Also like Groupon, InnerWorkings' business model is driven by high cash burn.
InnerWorkings has been very acquisitive. This has helped grow the top line, but done little to bolster the company's cash position, which stood just shy of $27 million in 2007 before dropping to $2.9 million in 2009. Last year, the company finished with $5.2 million. At the same time, unbilled revenue has climbed. Such revenue was $24.6 million in 2010, up from $20.2 million in 2009.
Which leads us to another company founded by Mr. Lefkofsky. Echo Global Logistics (ECHO) has fared a bit better. It IPO'd in October 2009, traded as high as $14 that month and currently trades around $15.50. But like InnerWorkings, Echo is heavily reliant on scale and big accounts, which account for 32% of sales.
The other 68% of sales come from less sticky transactions. And, just like InnerWorkings, the company has been very acquisitive. Over the first nine months of this year, Echo's revenue increased $127.4 million from 2010. However, $125 million came from acquisitions, which suggests anemic organic growth.
As a result, Echo's cash and equivalents have barely budged, finishing last quarter at $44.19 million, up slightly from $43.2 million at year-end. Accounts receivables, however, spiked to $84.2 million from $60.3 million during the same period.
And, looking through Echo's SEC filings presents some interesting relationships between the founders and the companies themselves.
For example, In January 2007, Echo inked a deal with Holden Ventures, LLC, a consultancy owned by Echo director - and Groupon co-founder - Bradley Keywell. In the deal, Mr. Keywell, through Holden, received over $200k in consulting compensation in 2006 and 2007. He also got options on 250,000 shares at $2.20 per share in recognition of his service to the company. Later, in June 2009, a group of directors operating as EGL Mezzanine loaned Echo $7.5 million at 13%. The majority owner of EGL Mezzanine, with a 67% stake, is Blue Media, which in turn is 100% owned by Mr. Lefkofsky. Both Mr. Keywell and Mr. Lefkofsky have made out nicely on Echo.
Interestingly, InnerWorkings has been a big beneficiary of Echo's going public too. Back in 2005, InnerWorkings acquired 2 million shares of Echo for $125,000. In the ensuing years, the company has been selling its position at hefty gains. By 2009, its position had dropped to 1.255 million shares. And, at the end of 2010, the company was still sitting on $2.799 million in unrealized gains after disposing of 271.9k shares, which produced a gain of $3.578 million. This is a fantastic return on its $125k investment, however, again it has done little to boost InnerWorkings' balance sheet.
It's also not surprising, given the inter-relationships and stock position, that InnerWorkings is an Echo customer. Echo billed InnerWorks $2.7 million in 2008 - up from $748k in 2007. Last year, Echo billed InnerWorkings $5.7 million. In the nine months ending September, Echo billed InnerWorkings $6.1 million, $3.1 million of which came in Q3 alone. In reciprocal fashion, but to a much smaller extent, Echo is a customer of InnerWorkings. InnerWorkings charged Echo $60k for services in 2010, down from a peak of $140k in 2009.
The deals across InnerWorkings and Echo expand to include Groupon too, with each helping the other through subleasing office space. In April 2010, Echo agreed to sublease from InnerWorkings, paying the $12,000 a month. In 2010, Echo paid InnerWorkings some $108k under the agreement. In August '09, InnerWorkings agreed with Groupon for Groupon to lease office space too. Groupon paid $18k a month, including $54k in the first three months of 2010.
Once the sublease with Groupon ended, InnerWorkings entered into a new deal with Groupon related to corporate procurement cards. The Q2 2010 deal allowed Groupon to obtain such cards under InnerWorkings existing credit arrangement. In exchange, Groupon pays InnerWorkings $64k a year.
We can't forget Echo, which also had a deal to sublease space to Groupon from May 2009 through April 2011. In the 9 months ending Q3, Echo had received $37k in rental income from Groupon.
Echo, with trailing sales of $553 million, sports a market cap of $346 million. Meanwhile, InnerWorkings, with 12 month trailing sales of $589 million, has a market cap of $395 million. Should Groupon be valued significantly higher to sales? Possibly. But, all three are scale-driven enterprises operating in highly competitive fields.
On the surface, doing business with one another makes sense, particularly if the companies can leverage savings. Of course, this assumes due diligence is being done too. At times, entrepreneurs have to provide additional funding and certainly management deserves to unlock its considerable investment for profit. However, these actions don't necessarily translate into shareholder gains. And, at a minimum, all the moving pieces of limited partnerships, consultancies and financing deals raise questions which are often the enemy of shareholder profits.
All the information is disclosed in SEC filings such as 10-Qs, and anyone interested in buying shares in Groupon should read all of InnerWorkings' and Echo' filings.