By ROLFE WINKLER
Turning down $6 billion never looked so smart.
That was the price at which Google offered to buy Groupon in December. Now, with the daily-deal website set to generate perhaps $3.5 billion of revenue in 2011, up more than 100-fold from 2009, it will surely secure far more when it stages its initial public offering.
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But investors should think hard before jumping on the bandwagon. First off, given the euphoria surrounding the IPOs of lower-profile, slower-expanding companies LinkedIn and Yandex, by the time investors can buy into Groupon the price is unlikely to be in tune with the daily bargains it offers.
More important, the picture that emerges from the company's financial statements is cloudier than the stupendous top-line performance suggests.
Groupon clearly has succeeded in building a huge user base fast and will no doubt gain an extra boost from hype around the IPO. And that gives it some room to differentiate itself. For example, a new product that enables subscribers to find nearby deals from a mobile device is only possible because of Groupon's huge number of merchant relationships.
In an interview with WSJ's Kevin Delaney, Groupon and LinkedIn investor Marc Andreessen insists that the recent popularity of tech companies does not constitute a bubble. He also stressed that both Apple and Google are undervalued and that "the market doesn't like tech."
But the biggest issue is the sheer cost of staying ahead of the pack. Last quarter, Groupon's gross profit, a more relevant measure than revenue because it strips out the cut that goes to merchants, was $270 million. But it spent four-fifths of that on marketing in order to acquire email subscribers faster than rivals. Include other operating expenses, and the company is losing money.
To create a patina of profitability, Groupon invents a bizarre profit-before-costs measure that excludes online-marketing expenses. These added up to a whopping $180 million in the first quarter. Excluding these and other costs flips the company's first-quarter net loss of $117 million to an "adjusted" profit of $82 million. But why should online ads be excluded while Groupon's Super Bowl ads aren't?
Investors shouldn't assume these costs will magically disappear. There is nothing to stop subscribers switching to rival deal sites. So, Groupon will likely need to keep spending heavily on marketing to boost its customer base and fend off heavyweights like Facebook and Google as they jump into the business.
Will investors snap up Groupon shares? Likely, yes. But are there also reasons to be concerned about the daily deals darling? Yes indeed. Shira Ovide reports.
But Groupon believes its headlong growth will translate into strong profits. It cites data that show North American subscribers acquired for $18 million in the second quarter of 2010 have since generated $62 million of gross profit. But, again, other operating costs aren't included in the calculation, clouding the picture.
Meanwhile, competition for subscribers is heating up. Overall, Groupon's marketing cost per new subscriber was $6.40 in the first quarter, up from $2.50 in 2009.
In addition to making it costlier to acquire new subscribers, rivals could attack Groupon's business in other ways. For instance, many offer a better cut of revenue for merchants. Outside the U.S., they may have extra room to undercut Groupon. In overseas markets, Groupon keeps all the revenue from unredeemed coupons, including the merchant's cut. Rivals that share the bounty may be more compelling for merchants to work with.
Groupon has every incentive to move fast on its IPO, in order to cash in while its expansion is in overdrive. But investors should take their time in assessing whether the company's explosive growth really will translate to surging future profits.
Write to Rolfe Winkler at rolfe.winkler@wsj.com
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