If you were one of the exclusive few invited to the Groupon East Coast Roadshow at the end of October, you were treated to an hour-long presentation, along with a spread of chicken salad, bread, chocolate chip cookies and tea or coffee, for lunch. If the growing excitement among the investing community surrounding the upcoming Groupon initial public offering (IPO) is any indication, the presentation must be making a much bigger impression than the lunch menu did. This practice of technology startups inventing metrics to mask their lack of net profits, dates back to the dotcom bubble of the 1990s, when companies invented metrics like "eyeballs," which was a means of measuring how many impressions a website received, even if those impressions didn't translate to paying customers. (For more on the dotcom bubble, read Market Crashes: The Dotcom Crash.)
TUTORIAL: Behavioral Finance
Call it Dot Com 2.0. Groupon, along with Facebook, twitter and LinkedIn, are the four best known companies using social media as a means of leveraging the internet for revenue. The revenue model behind Groupon is simple to understand: Companies use Groupon's large 35 million member mailing list, to advertise too-good-to-be-true specials. Groupon sells the special directly to their mailing list subscribers and takes a cut of the revenue.
The company quickly ballooned to an estimated market value of more than $20 billion and saw record profits that, much like the specials themselves, some called too good to be true.
Groupon became a technology giant, which led Google to enter into talks to acquire the company. Those talks broke down in 2010, when Groupon decided to remain an independent company. Some speculate that Groupon would have had trouble meeting the terms of any potential deal, which might have required the company to meet aggressive growth benchmarks, something that may not have been easily accomplished, given Groupon's already large market exposure.
In July of 2011, something caught the eye of the Security and Exchange Commission (SEC) as they reviewed the IPO filing. The "adjusted consolidated segment operating income" or COSI was a little understood term which, according to the Wall Street Journal, is designed to divert investors away from Groupon's marketing costs. This was a source of great concern, because of the apparent disproportionate share of company funds being used to acquire new customers.
Groupon intends to raise as much as $540 million in its initial public offering, due to hit markets on Nov. 4. According to their filing, they will offer only 4.7% of their outstanding shares, which is sure to create large scale demand among investors.
Still, some Wall Street insiders caution retail investors to think twice. Jim Cramer, host of the popular show, Mad Money says, "I think you'll get an initial pop, but after that you don't want to be left holding the bag."
Skeptics caution that Groupon's sales have dropped off drastically during 2011 and that may be signaling that the company is becoming a victim of increased competition, as well as market saturation; that doesn't make large scale growth possible, going forward. In October, Groupon announced that it had a net loss of $214.5 million to date, in 2011.
Other investors seem convinced of the long term potential of Groupon. So, what should you do? Cramer believes that you should let the dust settle on this IPO. Don't purchase on Nov. 4, and probably not for quite a while after that. (For more on IPOs, check out How An IPO Is Valued.)
The Bottom Line
The Groupon IPO hits the secondary markets this Friday, Nov. 4, and although it's sure to be the story of the day in all the financial media outlets, you may be best served to not buy in to the hype. There will be plenty of time to buy this stock once the celebrity status premium is sold out of it.
This practice of technology startups inventing metrics to mask their lack of net profits, dates back to the dotcom bubble of the 1990s, when companies invented metrics like "eyeballs," which was a means of measuring how many impressions a website received, even if those impressions didn't translate to paying customers. (For more on the dotcom bubble, read Market Crashes: The Dotcom Crash.)