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The Brode Report  |  September 2011

David Brode profile   Try though I may to avoid talking about Groupon again, the news has been coming so fast that I have to address it one more time. It's been busy here at world headquarters of The Brode Group, with not one large project dominating the workload, but many smaller ones. Singles and doubles add up!

I hope you enjoy the Groupon analysis and, if they ever IPO, I advise you not to buy. You may also read my previous posts on Groupon here.
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I Can't Resist: More Groupon Analysis, Plus More!

First we have the creative accounting. We've already discussed how they had to drop their ACSOI (Adjusted Consolidated Segment Operating Income) measure which was similar to the roundly discredited EBITDAM of the dotcom boom times because it excludes marketing costs from, well, a marketing company. Now after consultations with the SEC (the financial regulators, not the junior-NFL collegiate league), Groupon is cutting their reported revenue in half. Previously, when you bought a deal for $10 giving you $20 at a nail salon, Groupon reported $10 in revenue and then gave the merchant $5, leaving them with $5. Now they are only reporting the $5 as Net Revenue. From my perspective, this seems like a minor point. Groupon actually collected $10 from a customer and has to pay the credit card fees on the full amount, so I was willing to call it revenue. Still, getting slapped twice for accounting is unusual for a pre-IPO company and is of note.

Next we have the Andrew Mason letter of August 26th. Aside from potentially violating the quiet period before an IPO, I have other issues with it.

Mason states: "We are currently spending more than just about any company ever on marketing--in Q2, we spent nearly 20% of our net revenue on marketing, while a typical company spends less than 5%." Um, really? More than any company ever? Well if Groupon's net revenue was $312M, 20% of that is $62M. At an annualized rate that's $248M, call it $0.25B. Granted, that's a lot of money. But more than "just about any company ever?" Heck, I did a quick Google search and found that in 2010 Proctor & Gamble increased their ad spending by $1B to over $8B per year. And that's just their advertising--it doesn't include a myriad of activities that fall under sales & marketing. Is it just me that finds Mason's statement megalomaniacal?

Also, where did he come up with the idea that companies only spend 5% of revenues on sales & marketing. I recall a time in the '80s or '90s when Bill Gates was testifying and in an aw-shucks kind of way said something like "I just thought you had to build good products and you were done" in response to questions of market power. At that time, MSFT was spending as much on sales & marketing as on product development / management, each at about 30% of revenues. Fact is, most business spend lots more than 5% to attract and keep customers. If you're spending less than that, good on you.

I can't understand why Mason sent out that email. I bet he wishes he had taken Google's six billion dollars last December.

More Groupon Analysis

1. Rob Wheeler published a solid piece about Groupon in the Harvard Business Review. Basic contention is that they grew before they figured out how to be profitable, so they are just losing money faster than ever.
2. Groupon's cost of revenue is soaring.

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Inevitable Profitability

I see many models that are a variation on this theme: we start with actuals for revenue and expenses. Then, we grow revenue a certain amount each year, maybe 10%. Then we grow expenses, too, but at a lower rate, say 5%. Guess what happens? In these models, it's inevitable: profits increase nicely.

Is anyone really convinced by these models? I find the power in financial modeling to be in forcing you construct a paradigm and then having you justify assumptions that go into the paradigm.

It's not inevitable for revenues to increase 10% per year. You need to go out and find the customers. That takes sales & marketing investment. Customers may take a while to ramp up. Extra investment may be required to serve higher volumes.

It's that kind of interplay that gives real intelligence to the modeling exercise. Then you can plug in assumptions for a variety of scenarios and see what the likely range of outcomes is for, say, fundraising requirements.
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