Groupon Shows How Not to Invest

When Groupon (NasdaqGS: GRPN) went public in November 2011, Investing Daily’s Jim Fink labeled it the worst Internet IPO of the year.

Just over 12 months later, it’s hard to argue with that call. Groupon has plummeted 88% from its IPO price of $20. Even Facebook (NasdaqGS: FB), after its botched IPO, looks good compared to Groupon, with a fall of “only” 40% since its initial offering back in May.

Bad News Keeps on Coming for Groupon Investors

Groupon’s latest stumble—a one-day 30% plunge to an all-time low of $2.76—came on November 9, after the company released yet another disappointing earnings report.

In the third quarter, Groupon’s revenue rose 32% from a year ago, to $568.6 million. The company lost $3.0 million, or nil per share, compared to a loss of $54.2 million, or $0.18 a share, a year ago. Both figures missed the Street’s expectation of $0.04 a share in profits on revenue of $590 million.

Groupon CEO Andrew Mason pointed “continued challenges in Europe” as the main reason for the disappointing results. But that’s an oversimplification of the problems at Groupon. More worrying is the fact that its revenue growth has continued to slow as the daily deal craze fizzles.

“In the fourth quarter of 2011, in its first earnings report as a public company, Groupon said its revenue nearly tripled,” writes the San Jose Mercury News. “That fell to 89 percent in the first quarter of this year, 45 percent in the second quarter and 32 percent in the third.”

What’s more, Groupon has never turned a profit, either prior to its IPO (see page 7 of its SEC registration statement) or after.

5 Key Reasons Why Groupon Is Struggling

Here are five other reasons why the daily deal site has fallen so hard in the past year. They also provide a good illustration of things to keep in mind when you’re deciding whether to add any new stock to your portfolio:

1. Groupon faces stiff competition: At the end of the second quarter, Groupon controlled 53% of the daily deals market in the U.S., down from 56% in the previous quarter, according to data from industry research firm Yipit.

The company’s biggest competitor is privately held LivingSocial, with a 22% share, followed by Amazon Local at 20%. However, it also faces a growing number of small, locally based competitors in its main markets. As well, Google (NasdaqGS: GOOG) has also entered the daily deals space with Google Offers. The move came after Groupon rebuffed the search giant’s effort to buy the company for $6 billion prior to the IPO.

You have to think they’re regretting that decision: Groupon’s market cap—the value of all its outstanding shares—is now just above $2 billion.

2. Groupon’s business model is easily duplicated: The reason for the heightened competition? Groupon’s business model—of sending out daily emails offering recipients deals on a wide range of products or services—is easily copied.

As a result, the company is scrambling to move beyond daily deals. To that end, it launched Groupon Goods, an e-commerce site that sells a wide range of products. This business accounted for almost all of the company’s revenue growth in the latest quarter.

However, selling products directly gives Groupon lower profit margins than the daily deals business, under which it simply connects vendors with customers and takes a cut of the sale. The company also faces massive competition in this space, including (NasdaqGS: AMZN).

3. Groupon’s customers are frustrated: The appeal of the daily deal coupons is clearly wearing off for the consumer. That’s partly because the discounts often come with strings attached that make them less convenient than they seem.

Even worse for Groupon, the retailers it relies on to provide the deals are souring on the strategy. A recent Raymond James survey found that 39% of merchants who had tried Groupon promotions were unlikely to do so again in the next couple years. Reasons included overly steep commission rates and the fact that one-off deals are a lousy way to encourage repeat customers. The study also showed that 32% of the businesses had lost money on the promotion.

4. Groupon has a long record of accounting issues: The company has run afoul of the SEC on numerous occasions, including having to restate its 2011 fourth quarter earnings, as Jim Fink writes in “Groupon’s Cooked Books: Beware IPOs With Shady Histories”:

“On March 30th, Groupon announced that it would need to restate its fourth-quarter financial results because of a ‘material weakness in its internal controls.’ Specifically, its initial reporting of fourth-quarter results back on February 8th overstated revenue by $14.3 million, operating income by $30.0 million, net profit by $22.6 million, and earnings per share by $0.04.”

That’s just one of the problems the company has had with overstated results. Others included two orders from the SEC to refile its registration statement in the run-up to the IPO. In the first instance, in August 2011, Groupon understated its operating losses by $120 million. The second time, the SEC ordered the company to lower its 2010 revenues by $400 million to reflect only net revenues and not revenues paid out to vendors.

5. Groupon has a turnover problem: The company has now gone through three COOs in two years. In addition, in August it was revealed that Groupon’s head of national sales, Lee Brown—who had only been with the company since December 2010—was leaving. The news came shortly after the departure of Jayna Cooke, one of the company’s leading salespeople.

Bottom line: A company with even one of these problems represents a huge risk to your investments. One with all five should be avoided at all costs.

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