How to justify Groupon’s valuation

By Felix Salmon
October 27, 2011
Henry Blodget has a smart post on how to value Groupon today. Is he right that it's vastly overpriced at a $10 billion valuation?

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Henry Blodget has a smart post on how to value Groupon today. Is he right that it’s vastly overpriced at a $10 billion valuation?

Blodget’s main thesis is that revenue growth at Groupon is slowing — and that transitioning from a high-growth company to a relatively modest-growth company is something which tends to hurt stocks. He’s the expert on such things; I daresay he’s right. But just for the sake of symmetry, here’s a simple bull case for Groupon, and for how it could get its really high revenue growth back.

Basically, Groupon’s been involved in a race to get a huge email list together; its revenues have largely tracked its subscriber base. After all, if any given deal is going to be bought by X% of your subscribers, then your revenues are going to be directly proportional to the number of subscribers you have.

Recently, Groupon has found that its earliest subscribers were its most valuable subscribers, and that it’s getting diminishing marginal returns from the 100 millionth subscriber. So it’s spending less money on acquiring new subscribers, and that’s feeding into fewer new subscribers and slower growth.

But Groupon has its huge subscriber base now — which means it’s ready to attack Phase 2 of its plan, and really start monetizing them.

Think of it like this: up until now, Groupon has been selling daily deals to customers. And it’s now ready to pivot, and start selling customers to merchants on many other fronts.

Right now, customers don’t spend all that much money on Groupon: in the first three quarters of 2011, its 142,865,836 subscribers spent $2,754,633,000 in total. That’s an annualized rate of about $25 per year. People love deals, but it turns out that the model of showing them one deal a day in their inbox is always going to limit how much they’re ever going to buy.

So Groupon is branching out into various other projects, all of which promise to increase customer spend dramatically — travel deals, high-priced goods, spur-of-the-moment impulse buys, you name it. Not all of them will work. But there’s a decent chance that some of them will. And if that happens, Groupon could easily become as valuable as, say, Priceline, which has a market capitalization of $24 billion. If you look at the size of the customer base, and the loyalty of those customers, it’s hard to make a case that a mature Priceline is five times more valuable than a mature Groupon. After all, Priceline is much more constrained in what it sells than Groupon is, and it reaches fewer people.

Which is not to say, of course, that Groupon is a buy at a $10 billion market cap. But I can easily see how such a thing could be justified, if the business goes according to plan.

22 comments

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How to justify Groupon’s valuation: drink some kool-aid.

I can’t believe I’m agreeing with Blodgett.

Posted by KenG_CA | Report as abusive

Groupon has lost its right to be trusted at face value. The SEC forced it to stop exaggerating revenue, which led to a restatement of over half of its revenue. Groupon lost its credibility with its constant financial fudging. Eric Lefkofsky may have pulled the wool over investors’ eyes with smaller companies, but he won’t be able to do so with Groupon.

Posted by Drummer80 | Report as abusive

Anybody who invests in a company that owns no intellectual or physical property in a sector with no barriers to entry is a fool…

Posted by mfw13 | Report as abusive

Your assumptions are (1) that Groupon’s mailing list can be monetized and (2) that Groupon’s management is capable of doing that.

Drummer80 has taken care of the second; Groupon’s management would be improved by adding Vikram Pandit to it, and I can’t get much more insulting.

Priceline’s customers are used to occasional emails, and even more occasional usage. I would give odds that 1/4 of Groupon’s customers automatically send their emails to their spam folder, and that another 1/4 would if they knew how to do it.

Groupon has turned itself into AOL–and I don’t mean the overpriced-but-easy-to-use AOL of the mid-1990s. By the time their investors find out they’re buying VA Linux or mp3.com or, at best, Boston Chicken (a great idea until you realised they were going to spend their IPO money adding franchises to compete with KFC, at which point YUM ate their lunch), the Groupon management will be vying with Patricky Byrne to see who gets the most of Sam Antar’s attention through the early and mid-10s.

The new kid has already shown flagrant disregard for reality.

Groupon probably is worth about as much as pre-Shatner Priceline. They were bankrupt too.

Posted by klhoughton | Report as abusive

So, you are saying that $10B may be ok as a valuation if Groupon manages to completely change the way it’s doing business after its IPO, to the point that it bears little resemblance to what it’s doing right now, meaning that Groupon’s only real value is its mailing list and some vague customer loyalty?

$70 per email address seems a bit pricey. If someone is willing to spend $70 per customer, I’m pretty sure that someone can do a lot more than what Groupon is making out of each of its customers…

Sorry. Not convinced.

Posted by Frwip | Report as abusive

Wow! $70 per e-mail address?

I’ll sell you one of mine for $50.

Posted by TFF | Report as abusive

So what’s the spread on how many people will be in jail within five years of this IPO? Everything about this is terrible.

Posted by gwaitersesq | Report as abusive

OK, I am convinced now. Not that Groupon is worth 10 billion. But Priceline 24 bllion? No way! Maybe buying Groupon and shorting Priceline is the way to go.

Posted by TSTS | Report as abusive

As in internet marketeer I would interpret your point slightly differently.

Yes, Groupon’s early subscribers are more profitable than the later ones, but it is also true that the marginal cost of finding new subscribers increases over time quite dramatically. So if the old subscribers become inactive, then it can become incredibly expensive to find new paying customers. Does the Groupon business model support high cost customer acquisition? Yet to be proved.

Posted by NeilB | Report as abusive

It’s unrealistic to invest in a company based on what it might do in the future to monetise its large user base. If at least they had a clear vision of it in their business plan / flotation prospect, but that’s not the case. So why don’t they stay private (they’ll find funding anyway) and go public once they’ve really cracked an appropriate, long term business model?

Posted by fabiodebe | Report as abusive

Felix, you are in phantasyland because you just focus on Groupon itself and not on the market.

Every business that is easily duplicated by competitors has a NPV of zero. Groupon is such a business and soon competitors will drive revenues down.

Bye bye business case…

Posted by FBreughel1 | Report as abusive

There is another problem: no one knows for sure if the people that buys the coupons are the customers, or if the merchants are.

Posted by AndreKenji | Report as abusive

Another issue: Groupon’s common stock comes with extremely limited voting rights, so the bull case must substantiate the credibility of management. Does anyone want to do that?

Posted by jtemujinw | Report as abusive

Don’t

Posted by IQMS | Report as abusive

Just today, I got an email inviting me to use “Groupon Reserve”. This is basically Groupon’s version of Gilt City; discounts for high-end restaurants and services. What’s interesting is that it highlights a bigger problem for Groupon, which is the failure to capture multiple retail markets when they had the chance.

On the upper end, you have Gilt City, Bloomspot, and I’m sure many others.
On the bottom end, you have tons of competitors.
On the middle, you have Livingsocial, plus Google and Amazon muscling in.

Groupon was first to the largest market, but they were behind Livingsocial when it came to buying into the travel market, they were behind Scoutmob when it came to the mobile market (the failing Groupon “Now”) and they are behind Gilt City, etc. when it comes to the upper end market.

They can still grow and do well, but I’m sure all this competition means that they’ll have to be a little more merchant-friendly. Right now, I’m seeing increasing numbers of desperate low-end retailers on Groupon, especially in Groupon Now.

Posted by joelseearr | Report as abusive

Groupon is the internet equivalent of newspaper coupons. It’s nice to receive Groupon’s daily promotional email, but seriously, don’t they have anything better than pizza, Italian restaurants, spas, yoga and teeth-whitening specialists to promote. Doesn’t seem to me to be a sustainable business model with some serious competitors lurking in the background. They should have taken Google’s offer. Now they are just red meat!

Posted by richardwmay | Report as abusive

Analysis of Groupon typically leaves out the crucial role restaurants play in determining Groupon’s future. Without their participation, Groupon in dead. So the real question is can Groupon keep restaurants happy?

Restaurants view Groupon as a straightforward marketing expense. They lose money (and Groupon gains money) on coupons and they hope they will get customers to sample their offerings and become repeat, full-paying customers, thereby covering this initial marketing expense.

The question is whether or not this is cost-effective for restaurants. (They have plenty of other marketing channels they could use.) Attracting only coupon users is a recipe for bankruptcy. So they have an incentive to keep coupon use to a minimum. And if enough Groupon users don’t turn into full-paying customers, restaurants will pull out and Groupon will be dead, regardless of how many customers Groupon has or how well consumers like it.

Posted by 2contango | Report as abusive

@TFF

Nope. Not interested. Even for the low, low price of $50.

Posted by Frwip | Report as abusive

Agreed with 2contango. Groupon’s business model relies on:

(1) The willingness of restaurants and other businesses to offer a 75% discount in the hope of attracting repeat customers at the full price.

(2) The inability of competitors to elbow in and offer either restaurants or consumers a better deal.

(3) Cutting costs sufficiently to turn an operating profit.

I’m personally puzzled at their inability to turn the 75% discount into a profit. Admittedly they pass the majority of that along to the customers, and spend even more on convincing new customers to sign up with them, but it shouldn’t be THAT expensive to attract business. And if it is, then your business might not be as promising as you hoped.

A month ago we received a Groupon (actually a look-alike competitor) offer for a local restaurant that we’ve already visited a couple times and enjoyed. Still didn’t bite because the setup ultimately seemed to be more hassle than it is worth.

Will be hard to build a $10B business on that.

Posted by TFF | Report as abusive

Great website you have here but I was curious if you knew of any message boards that cover the same topics discussed in this article? I’d really love to be a part of online community where I can get feedback from other knowledgeable individuals that share the same interest. If you have any suggestions, please let me know. Thanks a lot!

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