Groupon Is More Hype Than Value

 | Feb 09, 2012 | 11:00 AM EST  | Comments
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Groupon's (GRPN) first quarterly report as a public company was not a good one. Shares fell more than 15% this morning and are struggling to regain some of that lost ground.

The report confirmed what many analysts had feared, that trying to understand how this company will turn into a profit-making enterprise is a murky proposition. The takeaway for investors? Owning shares in a social-buying site could be a classic love-hate relationship: a great business idea that leaves them holding the bag, hoping for returns.

A friend of mine who launched a small, successful social-buying site several years ago told me that the worst thing that could have happened for their business, and the industry, was Groupon going public. I'm certain there is fair degree of self-interest in that comment -- after all, going public was a very good thing for Groupon and its investors.

Groupon is burning through cash quickly. Aside from the tax issues that analysts expected to affect the bottom line, the quarter was a mixed bag. That uncertainty, coupled with losses, will likely exert downward pressure on the shares for the near future.

Meanwhile, the company continues to attract new users. Year over year, its active user base -- those who have made at least one purchase over the past year -- grew by 275%, to 33 million active users. Marketing costs, another huge line item, dropped by 22% year over year, and accounted for 30% of revenue as opposed to 100% of revenue a year ago.  

Unfortunately, those two seemingly solid numbers were overshadowed by bigger concerns. Despite growth in the user base, gross billings grew 8% in the fourth quarter compared with a 25% rate of growth in the third quarter of 2011. In other words, growth slowed significantly between the third and fourth quarters. Net margins were also worse in the fourth quarter of 2011, at -8.3% compared with third-quarter 2011 margins of -2.5%, respectively.

One quarter is not a fair assessment of a company's future, but analysts are not pleased. According to one J.P. Morgan analyst, the company's "lack of visibility" regarding subscriber growth and number of Groupons sold makes it difficult to model the company's performance. Groupon CEO Andrew Mason tried to address these concerns by putting the focus on net revenue as the most effective way to gauge the company's growth.

The net-net of it all is a not-so-clear picture of where Groupon is going. Indeed, it's common for tech startups to lose money early on, as was the case with Amazon (AMZN) and Netflix (NFLX). But those companies had products to offer; Groupon is spending tons of cash offering a service that is teeming with competitors because it's very easy to enter the industry with very little initial cost. Obviously, no new entrant will threaten Groupon's size, but Groupon can continue being the big name in town and still lose money.

Groupon's numbers also muddy the waters surrounding the profitability of users, and that's not good for the upcoming Facebook public offering. My guess is Facebook's hype will carry the day leading up to the offering. But the appeal of hype wears off quickly when investors aren't making money. The tech landscape has changed since 1999. Many of today's big players are churning out enormous profits and cash flows. In the process, shares prices are rising. If Groupon doesn't figure out how to make its much-hyped business profitable, investors are in for a rude awakening.

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