How I lost my Groupon bet

By Felix Salmon
November 10, 2012

Last year, when Groupon went public, I entered into a “small wager” with Rocky Agrawal. We would check back on Groupon’s market valuation in one year’s time, and compare it to the valuation of Priceline. At the IPO, Groupon’s market capitalization was 72% that of Priceline; if that number fell below 30%, I would lose. Otherwise, I would win.

Well, here’s what happened to that ratio:

ratio.tiff

This actually understates how badly I lost the bet. Shortly after the bet expired, two things happened: Priceline announced that it was buying Kayak, and Groupon plunged on disappointing third-quarter earnings. Today, Groupon closed at $2.76 per share, giving it a market capitalization of $1.8 billion. Priceline, by contrast, closed at $625.87; if you add its capitalization to that of Kayak, you get a total of $32.74 billion. Which means that the Groupon:Priceline ratio is basically down to about 5.5%.

Obviously, something went horribly wrong at Groupon after the IPO. So, what was it? Did Groupon suffer a massive loss in revenues? Did it start racking up enormous losses? Well, here’s the chart.

groupon.jpeg

The blue bars, here, are Groupon’s quarterly revenues, from the second quarter of 2010 onwards. The red bars are its net income. And the jagged line, of course, its its plunging share price.

The main thing to note is that Groupon’s results don’t seem particularly gruesome; they’re certainly better now than they were when the company went public. The share price didn’t fall because revenues were falling: it fell because revenues — and profits — weren’t rising fast enough.

This is why I’m generally so mistrustful of stocks: they just don’t behave in a remotely predictable manner. It’s impossible to know what kind of future growth rate is priced in to a stock, and it’s even more impossible to have a good grasp of what a company’s future growth will be. If you’re valuing fast-growing companies on some kind of discounted cash-flow model, then tiny tweaks to your growth assumptions or your discount rates can have an enormous effect on the share price which pops out the other end.

I knew this, of course, when I entered into my bet with Rocky. So what was I thinking? Three things.

Firstly, volatility cuts both ways. Groupon could fall precipitously — but it could rise very fast as well, in which case I’d be well in the money.

Secondly, I was already well in the money: Groupon stock could fall in half and I’d still win the bet. I don’t believe in the efficient market hypothesis, but I do believe that the markets are more efficient than any individual. Given the cushion that Rocky was offering me, I’ll take the side of the market against anybody.

Finally, the kind of things which hurt one bubbly tech stock tend to hurt them all. When we entered into the bet, Priceline had risen from just over $50 per share in the fall of 2008 to more than $500 per share in the fall of 2011. Rocky’s bet wasn’t just that the Groupon bubble would bust: it was that the Groupon bubble would burst and the Priceline bubble wouldn’t. Which, of course, turns out to have been exactly what happened: it wasn’t long before Priceline was trading at more than $750.

So, next time we’re in the same city, I’m buying Rocky dinner. At least I’m still winning the other bet, for the same stakes.

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