Dear Potential Investor,
I have mixed feelings about the Groupon IPO. On one hand, we’ve just come out of a horrible economic period where there was a real fear of wealth destruction. But now just a few months after the near-collapse of our financial institutions, we actually have an extraordinary opportunity for wealth creation — how great is that! On the other hand, there is no rational math that could possibly get anyone to the valuation Groupon thinks it deserves. Yes, Groupon grew from $30 million in sales to more than $700 million between 2009 and 2010, but most of that growth was artificial. (The lack of profitability is another issue, but let's not even go there.) Here’s why:
- $265 million came from its international markets, which were acquisitions.
- It spent a quarter-billion dollars (!) on marketing. To put that into context, the average large eCommerce retailer spends $11 million on interactive marketing. Back of the envelope calculations from the SEC filing get us to $31 spent to acquire a customer, who then probably spends a little more than that on Groupon. That means it spent about $250 million to make another $300 million.
- It launched in more than 100 new markets in 2010. I’ll conjecture that in any market in America, you can sell $500,000 of half-off manicures and teeth whitening procedures in a year just by hanging a shingle. That gets us to another $50 million in revenue.
In short, acquisitions, heavy marketing, and opening new “stores” (for which there are no markets left given that they’re now in Sioux Falls) get us to $615 million in revenues in 2010. That part of the so-called growth story is not sustainable. That leaves $96 million coming from truly organic growth in 2010. Now that’s not a shabby number given that its 2009 revenue was $30 million. But then that would mean its growth would only have been 233% and not 2,200%. (What a boring story that would have been!). And that would mean that even at a multiple of 20x revenue, the valuation would be closer to $2 billion, a far cry from even Google’s valuation last December and much less than the numbers out there now.
Let me be clear, this is fundamentally a decent economic model — there are no expensive fixed costs, and the merchant bears the inventory risk. Groupon won't go the way of Webvan. But the market opportunity isn’t as big as the industry players would like you to believe. That’s true for all the obvious reasons: It relies on discounting products, which attracts the wrong customers, merchants are hard to sell to, good merchants are more expensive to sell to, etc. This IPO game isn’t about finding value, it’s about finding a greater fool who actually believes the valuation is true. Trust me, you will be the fool. There will be plenty more IPOs coming up of companies with greater profitability and higher barriers to entry (e.g., social networks with hundreds of millions of followers). Those will be wiser investments. Give Groupon time to actually earn its valuation.