Groupon Files For IPO (And Why You Should Avoid It Like The Plague)

Michael Convente June 2, 2011 2

Groupon is generating a lot of buzz this afternoon after declaring that it has filed a registration form with the Securities and Exchange Commission (SEC) in preparation for starting an initial public offering (IPO).  With revenue increasing an insane 23X from Q2 2009 to Q1 2011, leading to Groupon being the fastest growing company ever, this announcement has been expected by financial analysts for some time.  Along with LinkedIn's recent IPO, plus already announced or expected IPO announcements from Pandora and Zynga, we could be heading into a dotcom 2.0 era.  And though you may be seeing dollar signs with these IPO announcements, if you remember the ultimate fate of almost all late 90s Internet companies, then you know you should exhibit a lot of caution when it comes to investing your hard earned cash.  After reading the fine print in Groupon's SEC filing it's clear that this scenario has all the makings of another dotcom bubble.


If you're too young to remember the original dotcom bubble back in the late 90s, here is a quick recap: With an exponential surge of internet connectivity in homes from 1995 to 1998, venture capitalists saw tons of value in internet commerce websites, not to mention the potential for generating millions of dollars from advertising (of note, in the early stages of Internet expansion, Internet advertising was way overvalued).  E-Commerce sites started popping up like weeds, and initially the reports were great, especially in regard to massive traffic growth.  Add in a very strong American economy, a general lack of business experience and acumen from executives, and a flood of money from venture capitalists, and you had the perfect storm for massively inflating company value. 

It may seem so obvious now, but during the late 90s executives and venture capitalists were first concerned with growing their user base rather than generating a profit quickly.  The standard operating proceedure was to spend ridiculous amounts of money to expand the user base, which would eventually lead to future profits.  Of course, when the market becomes saturated and you spend way more money than you can generate back, you have a major problem.

The end result: after only three years and spending money like it grew on trees, the dotcom bubble burst, leading to almost all dotcom-era Internet companies going out of business.  Some diamonds in the rough survived (notably and eBay, for starters), though those companies not only were founded in the very early stages of the Internet before the dotcom burst, they operated on sound business practices.

What do all of these companies have in common?  After being founded in 1998, all were out of business in only three years.

So you may be thinking, "OK, so people were dumb a decade ago, but we have a better grasp of things now and will make smarter investments".  Well, after looking at Groupon's prospectus, I'm not so sure.  Groupon seems to fit the model of a typical late-90s era dotcom company, which based on their performance history is not a good thing.  First the good – Groupon's user base has increased 545X and revenue has increased 23X (up from $3.3 million to $644.7 million) from Q2 2009 to Q1 2011.  This insane growth has broken the mold for any company in recorded history.  But here's the problem – Groupon is still losing money, and lots of it.  In 2010, Groupon lost $456.3 million, and in for the first three months of 2011, Groupon has lost $146.5 million, which equates to $586 million if extrapolated for the entire year.  So even though Groupon's growth has been unbelievable, they are on pace to lose more money than when a vastly smaller company.

And I haven't even mentioned potential competition for Groupon.  LivingSocial has decidedly locked in 2nd place (for now at least).  Smaller sites like RueLaLa and Gilt are more branded to luxury items, so they are doing fairly well financially, but they could easily branch into the local business market that Groupon pioneered.  In fact, Gilt has already launched local services in several cities across the US.  And I haven't even mentioned Google or Amazon, which are actively working on a coupon-model business similar to Groupon.  Simply put, the barriers to entry for Groupon's business model are far too low to ward off competition.  Sounds familiar, eh?

It appears that Groupon made a major mistake rejecting Google's $6 billion takeover offer.  And it's my opinion that if you invest in Groupon once the stock is offered, you will be making a major mistake.  I would not be surprised that if in a few years I can add Groupon to the list of internet companies that failed.  Unless you get out after 24 hours post IPO, you're looking at major losses for your portfolio.  Need an example?  See LinkedIn's stock chart

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