Felix Salmon

The Groupon roadshow

By Felix Salmon
October 21, 2011

Here’s something I haven’t seen before: an IPO roadshow appearing online for the world to see. (Click the link on the left; the link on the right basically just takes you to a copy of Groupon’s S-1.) In fact, I’ve never seen an IPO roadshow pitch before. They’re boring! And, they feature senior executives looking uncomfortable wearing ties in front of a dark-grey background, talking to slides!

But, this roadshow is also very helpful indeed for people looking to understand Groupon’s business. And it includes cohort information which has never been made public before, and which is rather more bullish on Groupon’s prospects than the analysis we’ve had to make do with to date from Yipit.

First, though, it’s worth taking a look at the price tag on this company. As Anthony Hughes reports, the price range indicated here values Groupon at no more than $11.4 billion, with Groupon itself getting a maximum of $540 million in cash. These are big numbers; the valuation is essentially double the amount that was reportedly offered by Google for the company in December, and is 2.3 times the $4.875 billion valuation at which Groupon raised money that month. (Interestingly, Groupon is actually raising less money in the IPO than it did in that round.) Still, the valuation’s nowhere near the $25 billion or even $30 billion numbers that were being whispered a few months ago.

Andrew Ross Sorkin is very critical about all that $30 billion number, talking about known issues surrounding Groupon, and writing:

How did so many Wall Street firms desperate to underwrite the Groupon I.P.O. miss these warning signs when pitching such a sky-high valuation? …

A deep dive into the numbers should have raised alarm bells at the outset about even talking about the possibility of a $30 billion valuation…

If it were to really slow its marketing spending, it is possible Groupon could turn a profit.

Even so, it does not fully explain how Groupon’s underwriters, whose endorsement of the company is supposed to be considered the Good Housekeeping Seal of Approval, originally came up with Groupon’s questionable $30 billion valuation.

Sorkin, here, is saying that Goldman Sachs and other banks, when pitching their IPO services, told Groupon that they could bring the company public at a $30 billion valuation — indeed, that they “originally came up with” that number. And, frankly, I don’t believe him. All conversations about these matters are off the record, of course, so it’s hard to be definitive. And Sorkin certainly talks to many more bankers than I do. But going public really isn’t about the IPO — it’s about being a publicly-listed company in perpetuity. And Groupon has very little incentive to launch at a bubblicious valuation which can only exacerbate volatility over time.

I think that the $30 billion number was never something that bankers seriously pitched to Groupon as a launch-valuation possibility. Instead, it was a number thrown out by people looking at LinkedIn’s first-day pop, and was intended to reflect not the IPO price but rather the level at which Groupon shares might trade in the secondary market, if the market remained frothy. (And even today LinkedIn is worth more than $8 billion, which makes $11 billion for Groupon seem pretty reasonable in comparison.)

As for Groupon’s business, I do still like the model — with the proviso that I have no idea how to place a present value on such a thing, so I take no position at all on what a sensible valuation for the company might be.

And in the light of the numbers Groupon released today, it’s no stretch at all to say that “Groupon could turn a profit”: the company’s total loss in the third quarter was a tiny $239,000 — essentially, the company broke even.

One thing which makes me look more favorably on Groupon now that I’ve seen the roadshow is the company’s cohort data. One of my biggest concerns about Groupon, up until now, has been the idea that its subscribers suffer from “deal fatigue”. You sign up in a fit of enthusiasm, you buy a few deals, and then the novelty wears off and you go back to your old life. That thesis was supported with charts like this one, generated from some of the relatively sparse information that Groupon provided in its S-1.

This chart could show that subscribers spend less and less money over time. On the other hand, it doesn’t necessarily show that. There’s an alternative explanation: basically, that there are diminishing marginal returns to marketing spend. Groupon picks the most valuable low-hanging fruit first, and then as its subscriber base grows, the newer subscribers spend less money than the older ones, bringing the average down. Even if the older subscribers keep on spending just as much as they ever used to.

And that’s what’s shown in two charts from the roadshow. They look at the numbers associated with the subscribers that Groupon acquired in the second quarter of 2010:

As Groupon CEO Andrew Mason explains with regard to the first chart,

This shows the repeat purchasing behavior of a typical cohort of customers; this one joined in Q2 of 2010. You can see that quarter after quarter after quarter, they continue to buy at the same pace.

The first chart shows the quarterly revenue from the customers that Groupon acquired in the quarter; the second chart shows the quarterly profit from those same customers. In both cases, the numbers are remarkably consistent over time — they’re not falling off.

My other big concern is about targeting — Groupon’s ability to differentiate between consumers based on much more than just what city they live in, and to show them deals they’re likely to love. Groupon product head Jeff Holden talks about this around slide 26. Groupon has something called Smart Deals, which tries to implement just that kind of targeting. One way it’s doing that is by getting its customers to click on categories called Deal Types, so that it knows what kind of deals that customer is interested in. And then of course given that customers keep on buying deals over time, it’s easy to see what kind of deals they’re buying, and what kind of deals they’re not.

Holden also gives the best explanation of Groupon Now that I’ve seen — the way it offers yield management for merchants.The idea is that the Groupon app on my phone is a great way for me to save money: I fire it up, and immediately see a list of deals nearby. Merchants can offer or not offer those deals in real time: they can make them better when business is slow, and turn them off when business is already overwhelming. That’s great for both merchants and consumers, who hate turning up to a Groupon-featured merchant and finding it overwhelmed with bargain-hunters.

There’s a rewards system, too. You know those punch-cards at coffee shops, where you get a free coffee after you’ve bought ten? That can now be built in to what the company is calling Groupon OS — all you need to do is allow Groupon to associate you with your credit-card number, and then every time you use that card to buy a certain item, it will automatically show up in the Groupon app. Eventually, you become eligible for a reward. It’s pretty effortless, for the consumer, and it brings an element of addictive gameplay into the shopping experience.

There’s a couple more slides which are relevant too, and directly address my concern that Groupon has to develop a reputation for high-quality deals. It can’t just let its salespeople maximize revenue, as sales people are wont to do: it has to delight its customers, by pointing them to great merchants. And it turns out that Groupon does actually attempt to do just that. One slide talks explicitly about “curation”:

And another (with the dreadful title “operational excellence”) shows the huge number of steps that need to be gone through before and after an offer appears on the site.

I love the way that under “Editorial” there are separate steps for “Humor”, “Voice Edit”, and “Copy Edit”. So there are systems in place here. But the really crucial step is buried somewhere in that “Deal Quality Assurance” circle. Groupon does not have the best reputation for picking only fabulous merchants; it probably needs to work on that a bit.

Overall, then, I think it’s pretty clear that people who think Groupon’s some kind of Ponzi scheme are wrong. There’s a real business here, with a real business model. The big question is whether Groupon can execute. Can it create a much-loved mass-market brand, which people and merchants trust and return to on a regular basis? We will always hear about bad experiences, of course — that’s a statistical inevitability, given the number of deals and employees going through the Groupon system. But will those significantly damage Groupon’s reputation? That’s a harder question to answer. (And it’s worth remembering, too, that for comparison reasons some small percentage of Groupon customers are going to have to continue to receive offers which are not targeted to them. If you’re one of those unlucky few, you might have a much worse experience of the company than everybody else.)

If I had to make a forecast, I’d say that Groupon is going to be around for the foreseeable future, but that the error bars on its future size are enormous. It could just slow down and lose its competitive advantage over its competition; it could, on the other hand, genuinely revolutionize the infrastructure of commerce and even become that thing everybody wants to be these days, a platform.

Like all fast-growing technology companies, Groupon is a risky bet from an investor’s point of view; it’s in no sense a widows-and-orphans stock. Like many consumer-facing companies, it’s probably better for most people to just take advantage of it as consumers. Individuals are much better at judging whether a money-off deal is a good one than they are at judging whether a particular stock is a good investment. But if Groupon’s sales continue to grow at anything like their recent pace, that’s an indication that a lot of individuals will continue to love what Groupon’s doing. And ultimately that’s going to show up on the bottom line.

6 comments so far | RSS Comments RSS

I happened to catch Cramer this morning saying that he thinks it will open at a $30-$40B valuation…

Posted by KidDynamite | Report as abusive

This surprises me; having never seen a roadshow myself, I had assumed they would feature investment bankers looking uncomfortable wearing ties in front of a dark-grey background, talking to slides.

Posted by dWj | Report as abusive

The Boston graph you posted might be a little skewed. Shortly after Groupon launched, Massachusetts cracked down on discounting alcohol because it violated their happy hour laws. We can no longer use Groupons toward alcohol in Massachusetts. That has personally made me stop buying them immensely. I’m not sure how much this has impacted sales overall though.

Posted by Bjolly | Report as abusive

“But going public really isn’t about the IPO — it’s about being a publicly-listed company in perpetuity. And Groupon has very little incentive to launch at a bubblicious valuation which can only exacerbate volatility over time.”

Felix, can you clarify this? The company’s major payout is the initial offering, not anything on the secondary market (unless down the road it wants to buy back stock cheaply, or issue more at favorable valuations… all of which pale in financial impact to the IPO). Considering their payout is based on the IPO pricing, they have every incentive to go public when things are frothy.

Posted by JohnMinLA | Report as abusive

Groupon is worthless for two reasons:

1) No barriers to entry for competitors
2) Owns no valuable intellectual or physical property

They’re nothing more than a glorified on-line coupon clearinghouse…

Posted by mfw13 | Report as abusive

if this is true you have to wonder how they set valuations at groupon
Did Groupon Value Its China JV Gaopeng at $500m in July? | DigiCha http://bit.ly/r1Zmd2

Posted by niubi | Report as abusive

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