Groupon Might Be Effectively Insolvent? - 06/06/2011

I'll start by tipping my hat to Andrew Mason. He caught social mood just right, creating a coupon/local/flashmob hybrid business model at the perfect time, and has created the fastest-growing company on a revenue basis in American history. That being said, it's operating like a Ponzi scheme that needs constant infusions of cash to stay afloat as it's hemorrhaging money.

We'll start by looking at the balance sheet, which is typically a waste of time for hypergrowth companies. However, for Groupon there are all kinds of red flags. They have $290 million in current assets ($208 million in cash) and $520 million in current liabilities -- current assets minus current liabilities puts them $230 million in the hole. This wouldn't be a problem except for the fact that they're wildly unprofitable, which we'll get to in a moment. Another concerning part of their current liabilities is that $290 million of it is "accrued merchant payables" -- in the US they take up to 60 days to repay merchants. So that $290 million is merchants who have rendered services waiting to get repaid by Groupon. Not exactly the best merchant experience. Oh, and by comparison, LinkedIn (LNKD) has current assets well in excess of current liabilities, and isn't losing money. (Also read The Groupon Rollercoaster: Investors Must Prepare for a Bumpy Ride.)

The income statement is even worse. In Q1 of last year they had net income of $8.5 million on $44.2 million in revenue, for a profit margin of nearly 20%. Not bad! At some point around that time, they decided to abandon a profitable growth strategy and went for the hypergrowth revenue strategy. For the remainder of the year they had $669 million in revenue (simply staggering), but had a net loss attributable to Groupon of $398 million. This year, Q1 results showed revenue growth continuing to soar, with revenues of $644 million, but a net loss attributable to Groupon of $102 million.

They lost $49 million in Q3, $313 million in Q4, and $102 million in Q1, with revenue leaping from $185 million to $396 million to $644 million, so it's incredibly difficult to have any idea what Q2 will look like let alone what the business will look like 6-12 months from now. That being said, the most likely reason why they're going public now is because they desperately need the cash, plain and simple.

There are all kinds of questions about the business. How can they possibly sustain this kind of revenue growth? Can they get costs under control? What about merchant and customer fatigue? How about deep-pocketed and savvy competition, either doing exactly what they're doing (LivingSocial) or coming to the table with a ton of customer data, i.e., Facebook and Google (GOOG)? The Daily Deal I got offered today was for a restaurant 30 miles away: how does that make sense either for the customer or merchant? How can you possible build a sustainable business by going from 0 to 8,000 employees in two years? Why did the COO and CTO both leave the company in late March, barely two months ago? How do you value a business that could do $3 billion in revenue this year but might not be able to keep the lights on in 12 months?

Most concerning of all, however, might be how their most recent capital raises have been handled. Their Series F and G capital raises, which occurred in April and December of 2010, raised a combined $1.08 billion. Of that $1.08 billion, $150 million went to the company for working capital purposes. The other $930 million? Paid back to founders and early backers by buying their shares from them. (For related content, see Groupon and Its Carbon Footprint.)

So a company that owes $230 million more than it has, and appears to be burning through $100 million or more a quarter, is using money raised from later investors to pay back early investors? Sounds vaguely familiar.  I'm not accusing Groupon of doing anything illegal or unethical. Ponzi, Enron, and Madoff all swindled their investors by misleading them about the financial health of their enterprises. As Minyanville's Todd Harrison likes to say, "The only difference between intervention and manipulation is communication." Groupon is telling you exactly what they are in their filing forms and by their actions. Invest at your own risk.

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