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Three Red Flags to Consider Ahead of Groupon’s IPO

Note from Louis Basenese: The IPO activity continues to heat up, with seven deals slated for this week – the busiest week for IPOs in nearly two months. But we’re still awaiting the announcement of the launch date for the biggest IPO – discount coupon giant, Groupon.

Given this highly anticipated event, we’ve already warned about blindly buying into the Groupon hype. Today, my colleague, Justin Fritz, reveals three more reasons why you should proceed with caution. Take heed!

After Groupon filed for its IPO in June, the company’s Co-founder and Executive Chairman, Eric Lefkofsky, told Bloomberg that the company “is going to be wildly profitable.”

The trouble is that the SEC limits what company executives can say before an IPO, meaning Groupon had to release an amended S-1 document last week.

The filing noted that Lefkofsky’s statement “does not accurately or completely reflect” what may be forthcoming.

It doesn’t mean he’s wrong, though.

The filing also discloses that, through the strategic use of an LLC, Lefkofsky and his wife have redeemed $386 million in Groupon stock.

Now, considering that their initial investment was only $546, I’d say “wildly profitable” actually hits the nail on the head.

That’s a 70,695,870% return on investment!

But will Average Joe investors, like us, be able to replicate Lefkofsky’s success?

As Louis warned here last month, we might not be so lucky once Groupon’s shares go public. And here are three more reasons why…

Red Flag #1: Subscribers Aren’t Actually Paying

By the end of the first quarter this year, Groupon boasted 83.1 million subscribers. That’s a 54,498% jump from 152,203 subscribers in 2009.

Impressive growth, for sure.

But dig deeper and you’ll find that only around 18% of those subscribers have actually purchased deals. Do the math and that means 67.3 million subscribers are pretty much worthless.

Not only that, the trend is declining, too. Back in 2009, 28% of Groupon subscribers were active users, which indicates that the company has merely acquired more dead weight, rather than actually monetizing its customer base.

Red Flag #2: The $198.7 Million Adjustment

Consolidated Segment Operating Growth (CSOI).

Not only is this metric verbose, it’s misleading.

Groupon originally equated its adjusted CSOI with “operating profitability before marketing costs incurred for long-term growth.”

In plain English, it simply means the amount of operating income without factoring in pesky expenses like online marketing initiatives.

In Groupon’s world, it translates into operating income of $81.6 million. But in the real world – after an accounting adjustment – that number is recast as an actual loss of $117.1 million. A difference of $198.7 million.

Groupon’s new filing does clarify that adjusted CSOI is “not a valuation metric.” But the fact that the company still uses it as a key performance indicator just doesn’t add up.

Red Flag #3: Groupon Has No Friends and Plenty of Enemies

With over 300 websites currently offering daily deals, competition represents an ongoing threat to Groupon’s future growth. And that competition increased big-time when Google launched its social networking platform, Google+.

Within two weeks, Google+ racked up 10 million active subscribers. According to All Things Digital, that’s likely “the fastest out-of-the-gate velocity of any social network ever.”

So how does this affect Groupon’s business? Two words: Google Offers.

Given the massive popularity of social media networks, they’re a very powerful way to catapult daily deal proliferation. And now that Google has a social networking vehicle (Google+) to complement its expansion into the daily deals area(Google Offers), it threatens to loosen Groupon’s domination.

Google’s direct line to 10 million new customers means its Offers service can hit the ground running once it launches nationwide.

And without a social network to call its own, Groupon’s only hope is for people to share their favorite deals on Facebook, Twitter and (ouch) Google+.

Bottom line: While we’re not predicting Groupon’s IPO will be a complete flop, all signs point to volatility. And like all IPOs, it’s best to exercise caution instead of getting swept up in the hype. And in this case, you’d be wise to give the brakes an extra tap.

Good investing,

Justin Fritz

Justin Fritz

, Executive Editor

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