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A complete write-off, clearly

A complete write-off, clearly

5.3.2013 12:52

Andrew Mason, Groupon (5,42 USD, 6,27%) CEO, was dismissed by his Board on Thursday. The reasons were, as described by commentators including The Financial Times, that Groupon, the company he founded and took public, was plagued by accounting missteps, disappointing earnings results and a plunging stock price. Mr Mason’s departing words were some of the funniest I have read on such an occasion: “After four and a half intense and wonderful years as CEO of Groupon,” he wrote, “I’ve decided that I’d like to spend more time with my family. Just kidding – I was fired today.” Analysts and business reporters alike commented the event with glee, saying that Mr. Mason should have been fired as chief executive a long time ago.

Groupon share price has been on a rollercoaster of a ride ever since the IPO in November 2011. Groupon IPO was hyped, like so many other tech IPOs, no doubt. Its initial pricing indication was $16-18, after strong market demand from, also typically, mostly retail investors, the company listed at $20 and the price quickly climbed to $26. A year later, in November 2012, it traded at $2.70. It is trading at $5.42 now, having risen by 13% immediately in after-hours trading on news of Mr Mason’s ousting, and going up since.

So what has happened? Why is the stock performing so miserably and why did the market cheer so much on Mr Mason’s departure?

For those uninitiated in the wonderful world of technology, Groupon is a US daily-deals website that features discounted gift certificates usable at local or national companies. In the Czech environment, you would have possibly encountered Slevomat.cz, Vykupto.cz or similar. In fact, dozens of deal-of-the-day companies have sprung up all around the world in the wake of Groupon’s runaway success. Groupon was launched in November 2008, so by the standards of any other industry it is a brand new company, a start-up, really. By the standards of tech, it is already an established business, so much so, that people didn’t even blink when the company announced its plans to go public in early 2011. An IPO of a company which is 2 1 years old and run by a young entrepreneur? Mason was 30 when the company listed, having graduated with a degree in music eight years earlier. Groupon (including an early version called The Point) was his first independent enterprise. I know that with hindsight, everyone is oh-so-smart, but isn’t it reasonable to expect that, given the circumstances, it will probably not be a completely smooth sailing?

Nevertheless, as I was saying, at its time the IPO was a hotly awaited event. Its lead-managers, pre-eminent investment banks Morgan Stanley (22,6 USD, 0,76%), Goldman Sachs (152,18 USD, 1,10%) and Credit Suisse (24,75 CHF, 3,00%), whose teams include some of the most seasoned and respected technology bankers in the world, recommended a pricing range, based on their assessment of the company business plan and reading of investor demand for the stock. The bankers, accountants and lawyers signed off on the offering circular. The IPO was a huge success, a big party. And then, of course, came the morning after, and the hangover.
Groupon invented a smart way of aggregating demand for discount deals using the internet. In a period of economic downturn when customers are highly responsive to price incentives and retailers and service providers desperate to shift their ware, Groupon thus single-handedly created a new industry, the daily deals industry, which grew exponentially. By default it became the largest player in this field, currently controlling about 50 percent of the daily deals market share in North America. Being the first and biggest in that sort of enterprise does confer certain advantages. However, the business has no barriers to entry and very high gross margins (in the sense that the cut Groupon takes of each coupon’s face value is very large). It is almost inevitable that such an enterprise is going to suffer slowing growth or margin compression.
 
A litany of complaints soon emerged among equity analysts and specialized media. The company was forced to revise its own quarterly revenue target, after failing to reserve enough for refunds. It had to change a key accounting metric, casting doubts on the reliability of its financial reporting. It then turned out that the explosive growth in revenues of the first two years was indeed unsustainable. Others have suggested, on the other hand, that the company’s expansion has been too aggressive. Reuters wrote, that “evidence mounts that the Groupon business model is fundamentally flawed”. The share price tanked. Equity analysts started issuing “conviction sell” ratings. In December 2012, Mason was named "Worst CEO of the Year" by influential commentator Herb Greenberg of CNBC.
OK, let’s take the complaints one at the time, starting with the revenue forecasts. In early November 2012, Groupon indeed reported they missed their 3Q revenue estimates, posting revenues of $586.6m instead of $591m. Although that is certainly no good news, it is also an error of only 0.7%. But it caused Groupon share price to drop to an all-time low of $2.70.

Another of the heinous crimes the company is accused of is the use of dubious accounting standards. Yes, it is true that Groupon back-tracked a use of a somewhat unorthodox accounting approach, signed off by all of those bankers and accountants. Facing regulator and analyst scrutiny, it changed the Adjusted Consolidated Segment Operating Income for more standard accounting metrics, leading to a change in profitability from an operating income of $60.6m in 2010 to an operating loss of $420m. Well, that is fairly material, one may say. The trouble is that this change was done well before the IPO, namely in August 2011 and was fully reflected in the final filing. No excuse for investors there.

It didn’t bother people much before the company listed that the early investors in Groupon decided to take the company public after they allocated most of the earlier $1.1bn in fundraising to themselves. A year later, everyone was citing it, going over the gory details of whether first investor Eric Lefkofsky took more money than the Samwer brothers, who sold to Groupon a European daily deals company MyCityDeal in 2010, and over who controls the company.

And what about the aggressive growth? In 2010, Forbes magazine declared Groupon the fastest growing company in history. That is a very high threshold to sustain, indeed. But Groupon didn’t promise public investors that the growth would continue at the same pace. The company naturally didn’t publish any financial forecasts in its prospectus, companies never do. To the contrary, in the IPO Prospectus, Mr. Mason wrote: “In the past, we've made investments in growth that turned a healthy forecasted quarterly profit into a sizable loss. When we see opportunities to invest in long-term growth, expect that we will pursue them regardless of certain short-term consequences. We are always reinventing ourselves. We are unusual and we like it that way.” Groupon Prospectus further states: “we may not maintain the revenue growth that we have experienced since inception. We have experienced rapid growth over a short period in a new market we have created and we do not know whether this market will continue to develop or whether it can be maintained. We have incurred net losses since inception and we expect our operating expenses to increase significantly in the foreseeable future.” You can still find the Prospectus online, on the official SEC website. If people chose not to read it they shouldn’t blame Groupon or its CEO.

By standards of tech industry, the response to the “offences” that Groupon has been accused of has certainly been completely overblown. The wrath of the tech media and analysts has singularly focused on Groupon and his CEO, while giving most of the other tech companies a huge benefit of the doubt. Just think a bit about the parallel career of Mark Zuckerberg of Facebook (27,72 USD, -0,22%) or Marissa Mayer of Yahoo (22,7 USD, 3,46%)! or the much less public profile of Dick Costolo, CEO of Twitter. Mark Zuckerberg, who presides over a company whose share price went from $45 to $17 (and currently trades at $27), has been named number 1 on Vanity Fair’s 2010 list of the Top 100 "most influential people of the Information Age" and number 16 in New Statesman's annual survey of the world's 50 most influential figures. Despite having mostly lost a large sum of money (Facebook IPO’ed at $38), investors care about Facebook and still like to follow each and every product update. Press coverage of Facebook all reads as if it has been manufactured by the company’s own PR department. Marissa Mayer, a long-term Google (821,5 USD, 1,90%) employee who became CEO of Yahoo! in July 2012 has been pronounced one of the most powerful businesswomen in America by Forbes despite the fact that in her 7 months in office she became most noted for having a baby while being a CEO, building a nursery in her CEO office and overseeing a major policy change in the office in February, forcing all Yahoo! employees who work remotely to convert to in-office roles or leave the company. For these achievements the investors rewarded her by boosting Yahoo! share price from $15 to the current $22.60. Clearly the investors don’t believe in telecommuting, either.

Seems to me that Groupon became the victim of its own success. Where the company is up to not very much (like Yahoo!) or is still hyped up on expectations on how to monetize its trillions of users (like Facebook), public markets will love you. If you are the fastest growing company in the world and then you slow your growth down to 30% (like Groupon), you are practically a write-off…


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