The dreary details of Groupon’s future
By Kevin Kelleher
The views expressed are his own.
Underwriting is usually a cheerless business. Taking a company public involves long regulatory filings, endless hours of due diligence and PowerPoint-driven roadshows. Investors need details, even if the details are dreary.
And then there’s the Groupon IPO. The daily deal company went public at $20 a share Friday and surged as high as 40%, briefly valuing the company at $20 billion. It may not be the hottest tech IPO so far this year — that distinction belongs to LinkedIn, which doubled its value on its first day — but it is the most discussed and divisive deal. Bulls and bears argue over the company and its future with a kind of passion that belongs to the culture wars.
On its face, the IPO is just about a company raising money, but it’s also so much more: It’s a spectacle — a dramatic tale of the fastest growing company in history brushing off a $6 billion bid by Google to go public and quickly become worth three times as much. It’s a scrappy outsider vindicating critics who attacked it mercilessly during an enforced quiet period. It’s a gaudy billboard luring other tech startups to come into the public markets.
What the Groupon story is missing, though, is all those dreary details. For all the metric-filled spreadsheets and PDF files of analysis, Wall Street is still a place driven by emotion. And the debate over Groupon is really about the difference between the emotional appeal of Groupon’s IPO and the less appealing story that lies in the minutiae.
A look at some of the details of the IPO itself suggest that this offering was carefully engineered to create a big splash. The prospectus lists 14 Wall Street firms, including Goldman Sachs and Morgan Stanley, the two biggest underwriters. These firms know that with a sluggish IPO market — only 18 companies went public in the third quarter, compared with 33 in the third quarter of 2010 — a big name IPO like Google or Amazon can whet the market’s appetite for more IPOs.
Groupon had been the biggest tech name in the IPO pipeline, but there were concerns this summer that investors’ interest might not be strong enough. So underwriters responded by ensuring that the supply of shares would be less than the demand. The result, according to Bloomberg, was the smallest float of any Internet IPO in the past decade: only 4.7% of its total shares. That raised $700 million for Groupon, less than the $900 million that Groupon insiders made from selling private shares in January.
That small float sets the stage for a secondary offering early next year, an offering that will likely involve Groupon insiders selling more shares. It’s a tactic that is already being deployed by LinkedIn, which sold 8.6% of its shares in an IPO six months ago, raising $353 million. On Thursday, LinkedIn announced a secondary stock offering of $500 million shares, only $100 million of which will be raised by the company itself, not insiders. That news drove LinkedIn’s stock down 6% Friday.
Groupon has a lot of data that’s appealing. Its revenue in the third quarter totaled $430 million, more than 5 times its revenue a year earlier and more than 100 times its revenue in the third quarter of 2009. It operates in 45 countries, and in 175 cities in North America alone, boasting a network of 79,000 merchants and 143 million subscribers around the world. If investors bought stock purely on past performance, Groupon would be a very attractive investment.
But nobody invests in the past, of course. And there are big questions about Groupon’s future. For one thing, the days of spectacular growth rates are over. Sure, Groupon’s revenue growth is impressive on an annual basis, but look at it quarter by quarter and you can see it slowing dramatically. A year ago, Groupon’s revenue was doubling sequentially every quarter. But beginning this year it began to slow dramatically: 72% growth rate in the first quarter of 2011, then 33% in the second quarter, and only 10% in the third quarter.
To keep growing, Groupon needs to draw more money from its merchants and subscribers. But case studies that Groupon included in its prospectus show that isn’t happening. In Chicago, average gross billings per subscriber fell to $14 last quarter, down from $22 in the third quarter of 2010 and $61 in 2009. There is a similar decline in Boston, another case study Groupon included.
There are other concerns. Before the IPO, Groupon owed almost twice as much to merchants as it held in cash. There is growing anecdotal evidence that merchants and consumers are burning out on the daily-deal business model. Meanwhile, the new business models Groupon is pursuing aren’t panning out yet. Some observers running back-of-the-envelope projections can’t see the stock worth more than $13 a share, half its current price.
None of that means that Groupon is necessarily doomed, but it does point to a lot of risk — risk that resides in the details and that grows more daunting as Groupon’s stock price rises. In the end, the cold details tend to win out over the market’s emotional side. Many of the hottest tech IPOs in the past year debuted with a strong start only to decline quietly in the following months. That trend seems to be especially strong with tech IPOs, which begin to underperform their peers after only two or three months in the market.
This IPO is not a happy ending for Groupon. It’s just a happy beginning.
Groupon Chief Executive Andrew Mason poses with his newly married wife, pop musician Jenny Gillespie, outside the Nasdaq Market following his company’s IPO in New York November 4, 2011. REUTERS/Brendan McDermid