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The Brode Report  |  June 2011

David Brode profile   Hi, this is David Brode. With Groupon filing for an IPO, I decided to revisit my February article on Groupon's valuation and see what the actual numbers in S-1 tell us. Your comments back are welcome, especially if you think this is a buy.

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Grouponís IPO Filing Shows the Inflated Bubble

A few months ago I wrote about my bearish view on Groupon. Now that Groupon plans to IPO, they filed Form S-1 with the SEC and for the first time we have lots of data to analyze about them. Bottom line: bubble city, here we come.

1. Groupon isnít profitable. Time was, you needed something like eight quarters of profits to IPO, but not today. Letís start with what we know: Q1 2011 revenue of $644M and ďearningsĒ of $82M. Letís talk about the ďearningsĒ measure, which they call CSOI (Consolidated Segment Operating Income). Groupon has been criticized for creating a new accounting measure, but itís close to the old EBITDAM measure which excludes certain Sales & Marketing costs. The actual operating income in the S-1 is ($117M), but for our purposes today Iíll spot them this one and treat it CSOI as EBITDA, but remember that lots of businesses look more profitable if you exclude Sales & Marketing. Especially companies that mainly do marketing, like Groupon.

2. Margins are at risk. The first thing I note is that the CSOI margin is pretty small: 12.7%. Part of this is a perception game. When you buy a Groupon for $50, Groupon treats that as revenue, which is fine. But it immediately pays 50% to a merchant, so it keeps $25. So if we treat that net amount as revenue, EBITDA margin doubles to 25%. Still, I think this points out a vulnerability in the business model. Thereís nothing magical about the 50% that Groupon pays to merchantsónote that some other group buying sites offer more. So if for competitive reasons Groupon were forced to match a 60% merchant payout, that EBITDA margin drops to 2.7% ... a 80% reduction. Ouch. Is it possible that Groupon could move the industry to a 40% merchant payout? Maybe, but Iím guessing pricing pressure works the other way based on the Porter analysis in the prior article.

3. DCF and Revenue per Customer analysis does not support the valuation. Next, I did a 20-year discounted cash flow analysis to get to the IPO price of $30B. Assuming margins hold up, I found Groupon would need to become a $100B company by 2022. For comparison purposes, that would put them in the top 50 globally today. That list is dominated by Oil & Gas, Automotive, and Financial Services. But of course #1 is Walmart, so if you believe that Groupon is that once-in-a-generation company, maybe theyíll be there too. But what does it take for Groupon to hit $100B in revenues?

Given the statistics in the S-1, I estimate that Groupon has revenue/customer of $45 in Q1 and revenue/subscriber of $11. The run rate for these is $180/year for customers and $35 for subscribers (math is non-linear due to averaging in Q1). With a run rate of $2.6B/year in 2011, Groupon needs to be 38x larger in 2022. If they maintain the $/cust and $/sub numbers, they would need three billion subscribers and 600 million customers in 2022. That, my friends, would be impressive market penetration.

This just doesnít seem credible. I keep trying to give Groupon the benefit of the doubt and the numbers arenít adding up for me. But hey, maybe Iím wrong.

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