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Nov 09

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Groupon: Valuation Pluses and Minuses.

The Groupon IPO finally occurred.  At least for the moment, the insiders are looking smart for rejecting Google’s six billion dollar offer for the local deals coupon site.  The initial day’s trading set the market capitalization of the firm at over twice that.

So it is either going to be the next Amazon or the next Pets.com.   I wish I could say for certain which, but I feel pretty confident in knowing why it will go whichever way it does.

Pluses

  1. They are the first to make a success in this market.  That makes it easier to stay one step ahead of all the people trying to imitate them.
  2. They have brand recognition as the market leader.  That helps in selling to small businesses who are both eager and cautious about new marketing opportunities.
  3. They have an established sales force.  At present, this is a business that gets cautious small businesses to almost give away their product or service for the hope of getting a new customer that will hopefully repeat.  Building a sales force is easy.  Building a skilled sales force is hard.
  4. Thanks to their IPO they have a war chest.

Minuses

  1. The business plan is easy to duplicate. It is already being duplicated, both by small companies such as Living Social and some of the largest companies on the Internet: Google and Amazon.
  2. Some of the biggest competitors have a competitive advantage in the perceived value to the customer.  Customers will perceive the daily e-mails as being more valuable if they are offers that the receiver might want to buy, even if they don’t.  If they eventually get tired of receiving so many daily deal e-mails they will drop the one that never seems to offer anything interesting.  Google and Amazon have massive consumer intelligence databases, Google’s data base contains everything that the user searches (thanks to tracking cookies).  Amazon’s data is based on what the user bought and reviewed on their site.  Both are way ahead of Groupon in targeting offers to the individual.
    Groupon can make up for the poor targeting by blasting the e-mail to even more people until the promised number of acceptances is reached.   But if Google can get the required responses with half of Groupon’s emails, then Google can service twice the number of merchants with the same number of subscribers.
  3. The larger competitors have a conversion advantage.  Groupon has essentially one marketing contact each day with their users.   With all of the web ads, Google has hundreds.  Let’s say that both Groupon and Google are going to sell coupons for a bungee jumping company.  Google can ‘warm you up’ to the idea by having a surprising number of the ads you see on the Internet in the week prior are connected with active recreation and thrilling experiences.  Then the bungee jumping coupon arrives!  Much higher conversion rate!  The conversion rate affects profitability by having the same number of subscribers service a greater number of merchants and offers on any given day.
  4. Groupon’s price may be being driven by shortage.   There was a large number of investors who wanted to have a little bit of Groupon just for the sake of diversification, but only a small fraction of the company was put on the market.   As the founders cash out or the company funds operations by floating additional shares, the shortage effect could diminish.
  5. Groupon is still essentially a closely-held corporation.  You have to trust the insiders because the general public only has a single digit percentage of the company.  Until that changes, if the insiders lose the trust of the general public shareholders, they will not be able to replace them.  If this happens, the public shareholders may rush for the doors.  Even if that scenario does not occur, one can expect Groupon to be more volatile than the general market.

Ultimately, under the Bigger Fool Theory, no investment can be foolish so long as you can find a bigger fool to buy your shares.  The person who spent fifty dollars to buy a Beanie Baby isn’t a fool if he found somebody who would pay sixty before the market crashed.  All the accumulated foolishness, like toxins in the food chain, accumulate to the person holding it at the end.  Is that the fate of GRPN?  My magic 8-ball says ‘Ask Again Later’, but a company with serious competitive challenges that is not yet profitable trading at a high P/E might not be an obvious choice for the buy-and-hold investor.

GRPN may be a fine investment at some point, but that will occur after the price of the shares has dropped and the company is more profitable.

About the author

Daniel Nolte

Architect, Network Administrator, Computer Forensics Administrator, Voiceovers. website,

Permanent link to this article: http://betweenthenumbers.net/2011/11/groupon-valuation-pluses-and-minuses/

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