There is no such thing as a free lunch.
Groupon (GRPN), as much as I would love to see it flourish, is indeed, finished. With Groupon, the stage was set for a cadre of plucky Midwesterners to prove that they could finally step up to the plate and compete against Silicon Valley California techies, Silicon Alley New York hipsters, Route 128 Boston Ivy Leaguers, and polished Fairfax-Montgomery County government contract offices in the high-stakes technology game. Although noble with his intent, I am doubtful that Groupon founder Andrew Mason will be able to convert his deal distribution idea into serious profits. Groupon is well on the road to bankruptcy, and is doomed to serve as yet another Economics 101 case study in bubble economics.
Put on your black suits, shades, and hard bottoms. The reaper is coming.
The Groupon Business Model
Groupon functions as an online intermediary that matches its army of deal-seeking consumer subscribers against local businesses that are offering discounts - in hopes of generating an immediate spike in sales alongside increased long-term demand for their services. As the middleman, Groupon splits incoming revenue and fees between merchants, in exchange for helping them to market their goods through online coupons and promotions.
According to technology consultant Rocky Agrawal, it is within our best interests to treat the Chicago firm as a "subprime lender," instead of merely accepting its coupon business model at face value. Indeed, Groupon's smoke-and-mirror accounting practices can only accelerate its demise, as investors struggle to interpret financial statements that closely resemble a Chicago Hillside Strangler interchange of revenue, refunds, and confusing "adjusted consolidated segment operating income" bridges to nowhere. Similar to the subprime crisis, it is only a matter of time before the Groupon business model is completely exposed, and its shares collapse towards zero and oblivion.
Rather than operating as a conduit for repeat customers to local businesses, Andrew Mason and company have created a bourgeoning class of savvy Web 2.0 coupon clippers, who capitalize upon the hottest daily deal at the expense of sustained consumer loyalty. In Chicago, the Groupon crowd runs the streets on a nightly basis for a taste of fine dining at Rush Street, Michigan Avenue, and the West Loop. It is obvious to all, from the regulars to the maitre d', that Cool Disco Dan in his fresh blazer and skinny jeans will never again set foot in this restaurant without his $20 coupon for a five course meal plus drinks.
Profitable enterprises will quickly realize that up-front cash flow from the Groupon crowd is merely a high-interest rate loan that cannot be leveraged into future earnings growth - and refuse to participate. Over time, the Groupon salesforce will be forced to compete against slick talking mob boss loan sharks in zoot suits - as the lender of last resort to struggling business owners.
History has proven that only gangsters, of course, can survive this subprime loan shark business, because they have the artillery to strictly enforce their "no refunds" policy and collect interest on demand.
Party Like It's 1999: The Web 2.0 Bubble
Yet, again, Wall Street has lost touch with any semblance of reality. According to Wall Street market capitalization, Groupon is a $9 billion business. Groupon, however, has never turned a profit. In fact, this coupon dealer is showing a trend of widening losses against larger revenues throughout its brief history of existence. Although reported revenue has tracked an impossible trajectory from $94,000 in 2008 to well over $1.5 billion in 2011, operating expenses have also snowballed from $1.6 million to $1.8 billion during this same time frame. After taxes, the end result calculates out to show a $373.5 million net loss, or a $1.03 loss per share.
Of course, all of these numbers can be taken with a grain of salt, as Groupon brass must now battle against a Pandora's box of SEC probes, class action lawsuits, and inevitable restructuring at the top - in response to their own accounting shenanigans and lack of internal controls.
In reality, I would surmise that Groupon tallied a $750 million loss in 2011. First, Groupon has booked all of the cash received for its coupons as its own revenue, instead of accurately splitting those dollars between itself and outside participating merchants. Secondly, Groupon has failed to set aside enough reserves to deal with a slew of inevitable refunds from irate consumers who have purchased coupons on big-ticket items that failed to deliver.
As an intelligent investor, I cannot justify any valuation for Groupon's shares that is one penny above zero.
The End of the Road
I am afraid that Facebook (NASDAQ:FB) and its looming May 2012 IPO will mark the capstone event for this Web 2.0 bubble. It is only a matter of time before Web 2.0 bubble stocks, such as Millennial Media (MM), Zynga (ZNGA), and Groupon unceremoniously implode beneath the weight of unrealistic expectations, insurmountable losses, and drying wells of investor capital. When the smoke clears, only Apple (AAPL), Google (GOOG), and Amazon (AMZN) alongside small, privately held niche sites, will be left standing as the real Internet players who can regularly turn profits amid the rubble.
Going forward, I feel that inflation expectations will accelerate the carnage. Inevitably, creditors will demand interest rates above the rate of inflation to generate real returns. At that point, money will flow out of equities and into fixed income, which will be the death knell of faltering stocks such as Groupon. The Fed will be helpless to contain the looming Web 2.0 collapse, because it has already ran out of ammunition to prop up the U.S. economy, as evidenced by its current zero interest rate regime and obscene $2 trillion balance sheet.
This is raw, survival-of-the-fittest capitalism. Groupon is finished. It's the end of the Web 2.0 world as we know it.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.