Commentary

Is Groupon An Overvalued One-Trick Pony?

The moment Groupon goes public later this year, it becomes a takeover target -- it can't happen too soon, given the latest turn of events. The daily deal wonder has effectively created a booming industry from scratch -- at a time when financially withering consumers are showing renewed reluctance to spend.

While Groupon scrambles to innovate ahead of the pack and explain its creative accounting to prospective IPO investors, the biggest risk to its sustainability is the uncertain economy. What good are deals without buyers?

Even as it plans to go public in a deal that could raise as much as $3 billion, giving it nearly a $30 billion valuation (more than what Google's IPO was worth in 2004, according to Bloomberg), Groupon fever is being dampened by sobering facts.

Groupon's success depends on consumer discretionary spending. Although global Internet traffic is expected to quadruple by 2015 to nearly 3 billion people, or 40% of projected population according to Cisco (per Mashable), not everyone will be wildly spending online. Among the many alarming deteriorating statistics is a sharply widening gap between consumer discretionary spending and consumer staples.

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Put another way, the continued decline in household debt (steadily contracting since early 2008), indicates that consumers -- including the nation's 24 million underemployed and unemployed -- are struggling to pay off debt and save rather than spend to fuel economic growth.

An eye-opening report by Bernstein Research analyst Craig Moffett, based on proprietary research, puts a fine point on such troubling economic trends. They have serious implications for media, cable and other related companies he tracks -- and most certainly for Groupon.

The bottom 40% of U.S. households has already exhausted  all of their disposable income, leaving nothing for discretionary cable, phone, clothing and debt service. While retailers and advertisers in general can play to the top 20% households (who account for 40% of retail spending), companies relying on universal economic support in highly competitive markets are headed for rough times.

Groupon's typical age 18-to-34, female user (as defined by eMarketer) is hardly insulated, given that the U.S. youth unemployment rate stands at more than 18%, or double the overall rate.

The current trending toward a second recessionary dip could see merchants avoiding subsequent deals and consumers unwilling to return to the deal well, except for the most relevant and justifiable reasons. Experts say there are signs that consumers suffering from deal fatigue are becoming more selective, and that only merchants with perishable inventories and a large fixed cost base are willing to engage in deep discounts. Increasingly, merchants prefer to more tightly control deals in their own space, on their own sites and apps.

Some of this reality was reflected in Groupon's first quarter numbers. Revenue per Groupon deal fell 8.7% to $22.95 last quarter, compared to the prior year period. The number of Groupon deals per merchant declined 21% to $612 from the year-earlier period. Although Groupon reported $645 million in first quarter revenues, up 1457% from the previous year, it's overall operating metrics are trending downward. Groupon's gross profits fell to 42% last quarter from 45.2% the first quarter of 2009, according to Wedbush Securities Internet analyst Lou Kerner.

While LivingSocial is the only real close competitor, daily deals are destined to develop into more of a long tail endeavor that can be whittled away by companies of all size playing to their own loyal customer base and specialized needs.

The daily deal space has been embraced by vertical deal sites (OpenTable), publishers like Daily Candy and The New York Times, consumer services (Gilt Groupe, Travelzoo, CityPockets, Lifesta) and aggregators such as Yipit. There is an active subset of exchanges that transfer daily deals from merchants to sales forces and publishers, and so-called white label providers focused on publishers with access to select consumers.

Groupon is answering the onslaught by accelerating its acquisition and consolidation of smaller deal providers. It's aggressively marketing past the $263.2 million it spent in 2010 on online advertising and subscriber e-mails, compared with just $4.5 million the year before.

Despite efforts to expand internationally, grab more real-time business with its new Groupon Now app, and move into new loyalty card memberships (to compete more directly with Foursquare), Groupon eventually may need to sell out to a dominant, broad-based player to remain relevant in a rapidly changing new market sector,

Acquirers could include online retailer Amazon, which just launched the members-only MyHabit deal-maker for designer duds, social media monster Facebook or advertising-based search giant Google, which offered a measly $6 billion to acquire the Chicago-based company earlier this year).

As Groupon's asking price swells, its market share is squeezed and constituents retreat in a slowing economy. Leading players will seek less costly, organic ways to scale daily deals.

The deal darling's vulnerability to deteriorating economics is being overlooked by the media in favor of more sexy issues, such as the apparent cashing out of  key Groupon executives, including its largest shareholder and co-founding chairman, Eric P. Lefkofsky. He is the focus of an unflattering Fortune write-up that has fanned the flames over Groupon's financial soundness.

Groupon's filing argues that its costs should more accurately be adjusted to exclude its exploding marketing costs, other future operating expenses and non-cash charges since it is a growing concern.

Analysts also have been quick to take Groupon to task for reporting first-quarter revenues of $645 million, when the company only really pocketed $270 million due to its generally 50/50 split with merchants. In its SEC filing and amid declining margins, Groupon warns investors that it cannot guarantee it will be profitable any time soon. It lost $413 million in 2010 as it intensifies its marketing spend to grow its 83 million subscriber base. 

Ultimately, it will be up to Groupon to demonstrate that it can be more than a one-trick pony. LinkedIn and Facebook, which could be valued at around $80 billion as a public company, have much more defensible, unique value propositions and market shares. You don't need to look much past your own pocketbook for the answer.

 

 

 

 

13 comments about "Is Groupon An Overvalued One-Trick Pony?".
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  1. Michael Michael kokernak from buyOTTads.com, June 13, 2011 at 8:15 a.m.

    Groupon, and the clones, are massive CAN-SPAM compliant opt-in lists. That is it.

    All they do is pool the interest from thousands of merchants and build one massive email list. They are nothing more than that and there is nothing special there.

    Discussion regarding the 'social' aspect is pure hyperbole ...when in fact the business model is simple and dangerously vulnerable. Internet Bubble at its finest.

  2. Paula Lynn from Who Else Unlimited, June 13, 2011 at 9:40 a.m.

    Let's say, Groupon's challenge is not only the facts you point out but also the dependancy and coordination of a revolving door salesforce with revolving door local management. Plus, some of their offers sound a bit wonky - $20 off $40 for a meal that costs $60 is not half off.

  3. Rick Monihan from None, June 13, 2011 at 12:18 p.m.

    In reality, consumer debt has continued to climb. The supposed "paydown of debt" that has been occurring has primarily been the writing of, by banks, of unperforming loans. Which, by the way, wind up getting financed by the Fed or taxpayers.
    While there is an improved effort by consumers, in general, to get their houses in order, it still is nowhere near a level to make an appreciable difference at a top line.

    This comment seems to have nothing to do with Groupon - which does play a role in helping households achieve some level of balance in their income versus spending.
    But there is a deeper problem, which is that while Groupon is "good" for consumers, it can also be a "bad" for small businesses. If they haven't checked their numbers well, it's quite possible that while using Groupon will drum up business, they could also be losing quite a bit of money in the process. For a young, untried, and struggling business entrepreneur that could be deadly.

    Which then ties back to my original point that was seemingly unrelated. Because in order to fix our debt problem, we need successful new small businesses. Lots of them. Small business is always the engine of growth and recovery. If Groupon actually helps them - terrific. I'm worried that it won't though, and Groupon may indeed prove to be the internet bubble 2.0 is what people claim: a bubble based on fake valuations, unfulfilled promises, and generating erosion of productivity in the economy.

    I hope Groupon (and similar companies) have thought long and hard about how to best build good, healthy business relationships that last. That is the best way to avoid Internet Bubble 2.0....

  4. Kevin Tynan from University of Illinois at Chicago, June 13, 2011 at 5:30 p.m.

    You can wring your hands over discretionary income and continued growth but the real issue doesn't involve economics. Groupon has no sustainable advantage over competitors. There is little difference between one coupon vendor and another and it seems Groupon will sell anything - yoga classes, tango lessons, dining -- anything. Better take the money and run because the valuation won't be there in a year or two.

  5. Howie Goldfarb from Blue Star Strategic Marketing, June 14, 2011 at 9:21 a.m.

    My issue with Groupon is the number of competitors out there popping up every day. And i see little reason to value them as high as they are right now. Plus most people ignore the deals. To me it is a gross margin give away for most businesses with little long term return for it.

  6. Rick Monihan from None, June 14, 2011 at 10:25 a.m.

    Chief and Kevin,
    I agree that an "advantage" is useful and meaningful. But I'd wonder what Ebay's advantage over Ubid or other bidding sites is (or was)? How about Amazon and other online retail sites (one click purchase? I don't think so)?

    Sometimes, it's all in the name and in the hype and if you can make it play, you can make it pay.

    That said, in the end, it will be about meaningful business relationships and building value. At this stage, I don't see a value proposition for Groupon and their business partners that creates long term value.

    In addition, it DOES involve economics and financial wherewithal. When households start to improve, as they will eventually, someday (hopefully soon, though who knows?) those same households seeking deals will stop seeking deals because the effort to get them isn't worth the savings.

    Today, we're in an economic position where many households are looking for any deal they can get, and taking it.

  7. Cam Yuill from AdTouch, June 14, 2011 at 11:42 a.m.

    Sorry Dianne, No offense, but I have to call BS on your thesis on declining discretionary spend effecting this market. Groupon started, and became widely successful, in the worst economy in living memory. People have always 'found money' for the discretionary things: beer, cigarettes, cable TV et al. What Groupon offers is something of value. If people are forced to spend less due to declining spending powers they replace more expensive items with lesser items. The most attractive are those that offer more for less. Precisely, the value proposition of the daily deal.

    Additionally, if the economy does decline, merchants need to find new (and more) customers just to survive. Most small businesses are Mom & Pop operations. Groupon offers an immediate pay check - enough to meet rent and put food on the family table - and it offers new potentially untapped customers that just might turn into loyal long term patrons. This exchange will always be attractive to merchants, especially in a tough market.

    As for the rest of you Groupon bashers, you have got it all wrong.

    Sure, there is nothing to stop the clones eating away at the market...except, just maybe, customer acquisition costs. There is a reason this is a two horse race despite the 100's of wannabes in the market. Groupon and Living Social are the ones with the cash; they can afford to spend marketing dollars to acquire (yet) more customers. The clones are failing because they don't have the capital to buy customers. Yes, we might see a well funded competitor (Google, Facebook) compete in the market but they are late to the party.

    Finally, I have a theory as to why so many people are beating up on Groupon right now. It's called envy. The model Groupon came up with is so incredibly simple that virtually anyone could have built this business. Or at least, that is how many of us feel. As an entrepreneur, I put my hand up: I wish I had come up with this idea and built the fastest growing company in history.

  8. Jay Levin from Kerr Hill Inc., June 14, 2011 at 12:26 p.m.

    Ain't no BS here, Diane. Just more of what we come to expect from you. Common sense wisdom supported by facts and a wide reaching view of the media and economic landscapes. With Groupon's possible evaluation growing to over what Google's was back the day, we really can see that the french saying "The more things change, the more things stay the same," holds true. And while I agree w/KT from Chicago about there being no sustainable value you can ignore the darling of the market in any vertical gets share. In an attempt to be so surgical in our logic here let's remember that investing is more emotional than we might want or like to believe. In the end could Groupon turn out to be the MySpace of its category. Ahh . . . yeah.

  9. Jay Levin from Kerr Hill Inc., June 14, 2011 at 12:28 p.m.

    One last note. What hidden factor could be driving this valuation up and up? Could it be Groupon's local sales force, hmmmm. Gotta wonder,

  10. Jonathan Tavss from Scarlet Strategic, June 14, 2011 at 4:46 p.m.

    I do agree with much of what's been said here. the valuation of Groupon and some other entities is a concern. Ultimately, though, the experience and connection to consumers is key.

    I wrote a more detailed commentary about this post on my Scarlet Strategice blog (http://scarletstrategic.wordpress.com/2011/06/14/groupons-valuation-the-30-billion-dollar-question/) but the key element that is being ommitted is the Marketing Value to the businesses when discussing how they might look elsewhere for discount distribution. Sure, they could offer the deep discounts on their own Apps, but then its not expanding the base.

    Groupon's drive to spend so many advertising dollars, I believe, is to keep growing those numbers so that they are unequaled. Certainly, questions can be raised about the effectiveness of that spending in an ROI sense. But, at this point, I would question retailers shying away from expanding their reach unless they were realizing true loss.

    I'm glad that there is now this more open conversation about valuations as we can't afford - as a community - to roll our eyes until the bottom falls out and then cry out "I told you so!"

  11. Mark Walker from aka Media Mark, June 14, 2011 at 5:41 p.m.

    Sorry Cam,

    But it seems the market is calling Groupon's bluff. While it is true Groupon succeeded in the worst recent economy- analysts are worried about what will happen as things get better and consumers begin to abandon their coupon habit?

    An initially high IPO is nice, but a long-term, sustainable model is going to get the best evaluation every time!

    Lesson here? Take it while you can get it and run before the pyramid collapses and you share a cell with Bernie!

  12. Ronnie Perchik from PromoAid, LLC, June 14, 2011 at 5:45 p.m.

    I personally think that consumer discretionary spending is the least of their problems. Competition (a jilted Google in particular), a hiring and spending spree that is unmanageable/sustainable. and general bad business decisions (Super Bowl Ad and post reaction) come to mind. But the most telling sign that they will have a bumping road going forward is their INACTIVE members. Estimates indicate that their inactives are at 50%, although no one knows for sure but them If it is anywhere close to that number, then that is a major problem.

  13. Rick Monihan from None, June 15, 2011 at 10:40 a.m.

    Cam,
    I have no envy of Groupon's success.
    I do have very big, legitimate questions about how it does provide value for small businesses.

    Small businesses that have used it aren't always aware of how much they lose in the process.

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