Imagine if Groupon’s wacky accounting caught on
By Robert Cyran and Rob Cox
The authors are Reuters Breakingviews columnists. The opinions expressed are their own.
The world would be a far richer place if Groupon’s wacky notions of accounting caught on. The Internet coupon company had an operating loss of $420 million last year. But it thinks investors in its upcoming initial public offering should look at “adjusted consolidated segment operating income” (adjusted CSOI) instead.
It’s easy to see why Groupon wants prospective shareholders to look at its accounts this way. Strip out marketing expenses, acquisition-related costs, stock compensation, interest expense and payments to the tax man and, presto, the Chicago startup led by Andrew Mason earned $60.6 million. If investors accepted this fantastical form of accounting, all sorts of companies would be worth billions more too.
Groupon argues that adding customers through marketing is a one-time process; stock compensation doesn’t result in direct cash outlays; and taxes and interest payments aren’t relevant because Groupon doesn’t have debt and is still technically “losing money.” In the real world customers leave and need to be replaced by new ones, stock options dilute existing shareholders, and taxes are eventually paid. But suspend disbelief and imagine how this thinking might impact the values of other companies.
Take Netflix. The online video company is growing at warp speed and spending heavily on marketing to attract new customers. Use Groupon’s arithmetic and this cost can be ignored. Netflix also pays taxes and rewards executives with stock. Subtract all of these figures from its 2010 accounts, and it would have had around $600 million of adjusted CSOI. Today, Netflix is valued at around 48 times trailing operating profits of $284 million. Substitute CSOI, and Netflix would be worth $28 billion, twice its market cap.
Or consider an old-school enterprise like Johnson & Johnson. Last year J&J had multiple product recalls. Under adjusted CSOI costs associated with these, like legal bills, advertising, and factory fixes may be treated as one-time expenses. And why stop there? Once a drug is invented, the formula isn’t forgotten, so research and development is a non-recurring cost too.
Do the numbers, and J&J’s CSOI would be about $10 billion higher than its 2010 operating profit line. At the same valuation multiple that J&J now fetches, using CSOI would add $100 billion to J&J’s worth. If Groupon is to be believed, the entire investment community has got its accounting all wrong.