initial public offerings (IPOs) trading on American exchanges

Tuesday, June 7, 2011

Groupon struggles to keep customers clicking

(Crain's) Groupon Inc.'s long-awaited IPO filing reveals troubling trends at the daily-deal site that has mesmerized the financial world with its quadruple-digit growth rates.

Customers are buying its emailed offers less frequently and spending less when they do. Groupon's share of revenue from its deals is shrinking as merchants demand a larger cut. And its costs are growing faster than its revenue as it scrambles to sign up more subscribers and merchants.

These trends cast doubt on the long-term investment potential of Groupon, which could command an initial market value as high as $30 billion, a record for a tech IPO. When the euphoria fades, hard questions are likely to follow about the company's ability to achieve and maintain sufficient profitability to support its stock price in the years to come.

To keep up its torrid growth, nearly doubling revenue each quarter, Groupon spends aggressively on marketing. That spending plunged it deep into the red, with losses totaling $545.8 million in the past four quarters on $530.0 million in net revenue (Groupon's share of the total revenue from its deals).

“The growth rate is going to slow a lot, and that marketing spend is going to continue,” says Bill Buhr, IPO strategist at Chicago investment research firm Morningstar Inc. “They could end up being upside-down for a long time.”

Groupon declines to comment. But in the prospectus, it warned: “We must continue to retain and acquire subscribers that purchase Groupons in order to increase revenue and achieve profitability. We cannot assure you that the revenue or gross profit from subscribers we acquire will ultimately exceed the cost of acquiring new subscribers.”

Marketing spending grew 3.5 times faster than revenue in the first quarter of 2011, Groupon's IPO prospectus shows. Detailed disclosures on the company's experience in the Chicago market illustrate the diminishing returns on its marketing dollars.

Between mid-2009 and the first quarter of 2011, its Chicago-area subscriber base mushroomed to 1.5 million from 36,891, net revenue soared to $9.0 million from $585,600 and the number of deals it offered rose more than tenfold, the prospectus shows.

But each subscriber bought less often, down to 0.6 Groupons per quarter from 1.3. And net revenue per individual Groupon sold dropped to $9.50 from $12.48.

“When you broaden the audience, you get less loyalty,” says Peter Krasilovsky, an analyst at BIA/Kelsey, a Chantilly, Va.-based research firm. “There's not enough track record to know what the loyalty of their customers is going to look like.”

' The growth rate is going to slow a lot, and that marketing spend is going to continue. They could end up being upside-down for a long time.'
— Bill Buhr,
IPO strategist,
Morningstar Inc.
Groupon argues that most of its marketing expenses are one-time costs to bring in subscribers, who eventually spend more than it costs to reel them in. During the second quarter of 2010, the company spent $4.86 apiece to acquire 3.7 million new customers who generated an average of $17 each in net revenue over the ensuing 12 months.

At the same time, the 50-50 revenue split Groupon became known for is tilting in favor of the merchants. The prospectus reveals that Groupon's cut is slipping toward 42%, and a source familiar with the company's financials says it's now 38%.

Groupon must find ways to keep merchants coming back, too. And it must attack overhead costs, which soared to 32% of revenue from 9% in the past year. Half of Groupon's 7,107 employees are sales reps who spend their days on the phone, trying to sign up merchants to do deals.

The company's recent launch of GrouponNow addresses both challenges. Unlike the once-daily email across an entire market, GrouponNow shows up on phones or computers of customers who are near a particular merchant. The deals are time-limited, instead of offers that can last up to a year, helping merchants draw customers during slow periods. After the initial sale, merchants can set up their own deals.

Analysts see the product as a sign that Groupon can adapt to the fast-changing business. “The current daily email offer is a pretty blunt instrument that's not very targeted,” says Rajeev Chand, head of research at Rutberg & Co., a San Francisco-based boutique investment bank focused on media and technology. “The folks at Groupon know that well.”

Dean Carson, owner of Carson's Ribs, offered a Groupon last fall when his downtown restaurant re-opened, attracting more than 4,000 buyers for a half-off deal. He isn't inclined to do another, but he likes the idea of a targeted deal through GrouponNow. “I could not afford to do a traditional Groupon again,” he says. “The economics didn't work.”

Mr. Buhr, the Morningstar strategist, says Groupon has to show it can perform over the long haul.
“If they can get a recurring-revenue model going, then you have a valuable business,” Mr. Buhr says. “The question is: Can they continue to innovate? If they don't, they're just another online-coupon site, and there are lots of those.”

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