Exclusive Deal Floats Groupon

NOVEMBER 5, 2011   THE WALL STREET JOURNAL

By ROLFE WINKLER

Behind every bubble, there is a clever investment banker. This time around, it's Morgan Stanley.

Even by dot-com standards, Groupon's initial public offering is puny in terms of the number of shares it actually sold to the public. According to Dealogic, dating back to 1995 just three U.S. tech companies floated a smaller percentage of their shares in their IPOs. Palm sold 4.7% of its shares in a $1 billion offering; Portal Software sold 6.2% in a tiny $64 million offering, and Ciena sold 6.2% in a $132 million offering. Then comes Groupon, which sold 6.3% this week as part of its $805 million offering.

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European Pressphoto Agency

Morgan Stanley has led the IPOs of Groupon, LinkedIn and Pandora Media.

That is well below the median of 21% for the 50 largest technology IPOs dating back to 1995, according to Dealogic.

Groupon's limited float strategy isn't new. Two of this year's other big Internet IPOs,LinkedIn and Pandora Media also sold a limited number of shares, just 9.4% of the total outstanding for both companies. Those deals were also led by Morgan Stanley.

Considering doubts about Groupon's business model, in order to ensure a strong first day's trading, the underwriters not only limited the free-float, but they also scaled back their original valuation target.

At Friday's close of trading, Groupon shares were at $26.11 apiece, 31% above the IPO price. That puts Groupon's market capitalization at about $17 billion, or roughly eight times next year's likely revenue. That is steep, considering that the daily-deals Internet company is still unprofitable and that growth appears to be slowing quickly.

Meanwhile, Groupon's main competitive advantage—its huge sales force—is being eaten away by rivals like Google and LivingSocial.

Indeed, slowing growth threatens the business model. After a daily deal is sold, Groupon holds onto the share of revenue that is owed to merchants for a period of time and uses that cash to feed its marketing machine. That works only when the business is growing, meaning that payments from new deals are coming in faster than payments on old deals are going out.

Groupon's IPO proceeds, which could fund a lot of marketing costs, take the pressure off on that front.

For the time being, the limited supply of shares should help prop up the price. The flip side is that a huge overhang of shares will come available for sale after the lockup period preventing insider sales expires next May.

The next big Internet IPO expected is online game company Zynga. Considering that it also faces slowing growth and rival Electronic Arts is suddenly chipping away at its dominance, perhaps investors should expect Zynga to limit its share float as well.

Morgan Stanley is leading that deal, too. Considering its success staging high-priced IPOs thus far, it has a strong pitch to lead the granddaddy of them all: Facebook.