Why Love Groupon? They Hated Amazon Too...
I’m warming up to Groupon because of all the hate. Let me preface this by saying I’m not a buyer yet. And I may never be. And I may be early. And I may be late. Regardless, I’m warming up and here’s why….
It’s hard not to love something everybody hates so much. A hyper-growth, money-losing, digital media company valued at around $15 billion by the secondary markets that some, like SAI/Henry Blodget, consider near insolvency (without noting the relationship between SAI and Gilt Group, one of Groupon’s would be competitors). How can you resist?
It doesn’t hurt that Groupon is smack in the middle of two megatrends: 1) a market that is potentially 9x larger than Amazon’s and 2) a continued shift of marketing dollars from offline to online.
But first, let’s look at the (obvious) negatives - since that’s what we hear about most these days….[[MORE]]
Andrew Mason, Groupon’s CEO, can act like a real ass. E.g., his response to the New York Times re dollhouses (kinda funny) or his interview on the Today show with Matt Lauer (kinda dicky).
Management, early investors, and other insiders have sold a ton of stock (i.e., around $1 billion). Yikes.
The company’s current business model may not be defensible, may have shrinking margins, may be slowing in some areas.
The balance sheet is a bit sketchy to say the least. Insolvency?!
They’ve already had some questionable accounting. 90’s era dotcom companies learned the hard way not to capitalize marketing spend.
But “somebody knows something…”
With all that said, some sophisticated investors have been willing to value the company at around $15 billion (and less sophisticated investors willing to bet it’s worth more than $25 billion). Well, maybe, somebody does know something….
Here’s the bull case:
Groupon cracked the nut on and profited from converting and tracking online marketing to offline sales. As Steve Cheney noted in June of this year:
…naysayers who are fixated on the current “daily deal” economics as long-term unsustainable are completely missing the point. The real innovation Groupon brought to the table wasn’t in advertising deals per se, it was their ability to profit off of closing the attribution loop in online-to-offline commerce. And this is a huge land grab that others had completely missed.
Moreover, the daily deals business is but one of many products the company can and will offer local merchants (kind of like how Amazon started by just selling books). Groupon has already added Groupon Now! location-based instant deals and imagine when merchants, whose customers are “connected” to them via Groupon (via daily deals, instant deals, location based alerts, and other mobile/social/local connections), can dial up and down sales, pricing, promotion, product, etc. in real-time depending upon real-time conditions. Or, better yet, you’re a consumer and you’re looking to get a dinner reservation, buy a product (now), or enlist a service provider (now) - rather than Googling/searching for where to place your (online) order, you use your Groupon-powered application to find the “best” deal, price, product, service, etc. near you now.
Offline Retail is 9x Bigger than Online Retail
That’s all well and good, but that mega valuation…. Well, how big is this market? E-commerce still only represented 6% of all retail sales in 2009 according to Forrester and is projected to be only 8% of all retail in 2014. That leaves over 90% of all retail effectively local by definition (thanks Marc Weiss for this observation). This is Groupon’s market. Amazon dominates online commerce like no other company with over 10% share and commands an enterprise value of over $80 billion. Groupon is facilitating local retail (possibly 9x bigger).
Now let’s take another step. Google, with its more than dominant position in search, “influences” more online buying behavior than anybody - and the market thinks it’s worth about $150 billion. Online ad spend is roughly 20% of total ad spend today and its gaining share quickly. (Forrester expects online sales to comprise 35% of total ad spend in 5 years.)
So, Groupon plays in the bucket of marketing dollars that could climb 15 percentage points in share and it is facilitating transactions in the offline retail business that is 9x larger than online retail. It doesn’t mean that even if Groupon executes to perfection it should be valued at 9x more than Amazon (or Google), but the opportunity should be clear.
Amazon.com, A History Lesson
Many of the criticisms of Groupon remind me of early Amazon criticism. And I’ll note that I was among those doubting Amazon’s potential. I was wrong (duh). In no particular order, here are a handful of the early seemingly obvious perceived flaws in Amazon’s business:
Amazon is taking a low margin business (book sales) and eroding those margins further.
Amazon is just a website that sells books - Barnes and Noble, Borders, etc. can easily build a website and they already have better brands, relationships with publishers, and resources.
Amazon will never be able to compete with mega retailers like Walmart, which, even more than the entrenched booksellers, have better brands, relationships with suppliers, and resources.
Amazon is competing with dozens of other online retailers like eBay, Overstock, Buy.com, CD-Now, Kozmo (I was an investor - don’t tease me - I’m still sore), etc.
Amazon isn’t profitable (and did not become profitable until 2001, almost seven years after it was founded).
Amazon’s valuation is ridiculous because it just sells books.
It’s the reflection on early Amazon doomsday predictions that really got my wheels turning. Those who were smart enough to see Amazon’s opportunity early (unlike me) did ask questions like:
What if Amazon is able to leverage its success in books to other markets?
What if Amazon is able to build a successful brand to compete against more traditional retailers?
What if Amazon expands into other services like auctions, payments, and e-commerce services?
What if Amazon is able to capitalize on the digital distribution of the media it sells in physical form?
What if Amazon can empower other web-based businesses?
We know the answer to those questions. Now. So, now, we need to ask can Groupon mitigate the negatives I laid out in the the beginning and can it exploit existing and forthcoming opportunities to grow into and above its massive valuation?
Re Andrew Mason acting like an ass: We’ve seen young CEO’s mature, grow into their roles, and surround themselves with the right people before. Bill Gates, Steve Jobs, Mark Zuckerberg, etc. have all had their moments. I could be willing to give Mason the benefit of the doubt here (plus, he does seem kinda funny).
Re insider stock sales: This is the toughest one for me. I certainly understand the fairness of taking some money off the table on the way up, but these guys have really pushed it with just how much they’ve derisked this endeavor for themselves. Then again, as Yipit’s Vacanti noted, they could have sold this company for $6 billion to Google and walked away, so why bother sticking it out unless they really believed they have something special they can prove?
Re the business model and competition: There certainly could be margin compression in one product line, but that could be (more than) offset by newer products and services. Competition continues to mount, but despite some reports on what I’d consider limited data in selective time periods, Groupon seems to be building quite a strong brand and growing quite nicely. (According to Yipit, Groupon recently took 48% share of the deals business while LivingSocial had 24%).
Re the balance sheet: If they do complete a massive financing, this issue should be significantly mitigated.
And re capitalizing their marketing expense: It is certainly debatable whether or not this is the right way to account for marketing. It’s also not a very new debate (see AOL, etc.) But it doesn’t really matter - savvy investors will value the company based on genuine metrics regardless of how the company chooses to present them.
(For a good critique of the criticism, read this.)
About that Marketing Spend….
Among the company’s biggest criticisms is its large marketing spend; e.g., according to the S-1, in the six months ended June 30, 2011, the company spent $379 million on marketing (and another $451 million on selling, general and administrative expenses) on revenue and gross profit of $1.5 billion and $611 million. Hardly unheard of for a company of its vintage and growing at its pace. But let’s indulge the critics - it’s big money.
That said, the company’s last financing round was rumored to be valued at somewhere around $6-8 billion. And, despite the fact that the company has paid insiders and existing investors out of its outside capital raises, Groupon Inc. did keep a meaningful chunk of cash.
So if Groupon is raising money by selling shares at a valuation some consider excessive and spending what some consider excessive amounts of that cash on marketing, what’s the problem? In effect, the company is getting its marketing spend at a bargain. And if they’re effective at leveraging those marketing dollars, the company could certainly leverage its growth to enhance its valuation. Sounds like a good tradeoff to me.
And About that Valuation….
Ok, even $6-8 billion is high for a new, private, unprofitable company with some hair. And $15-25 billion is, well, higher. Putting Groupon’s potential in-line with what Amazon and Google have attained ($80-150+ billion says the market) highlights Groupon’s prospects as a company and as a stock, but Amazon and Google have proven their potential (and profitability) very clearly over time. Thus, perhaps the real question is: does Groupon’s valuation and, for that matter, the valuations of other social media sweethearts (Facebook, Zynga, Twitter, etc.) adequately discount their risk. Amazon and Google didn’t have anywhere close to the pre IPO valuations of the Facebook-led social/mobile/cloud revolution companies (the size of Google’s and Amazon’s pre IPO round financings would support this), but two factors exist today that did not exist then:
Secondary markets for privately-held shares (e.g., SecondMarket, SharesPost, etc.) exist today and did not exist before - i.e., there is liquidity.
I believe the realization of the potential and the opportunities of these new companies is much more widespread and understood than those companies 10-15 years ago.
Are these points enough to account for the discount disparity? In the very short-term, maybe; in the long-term, ask your cab driver or your Aunt Suzie - they’re the ones that will have to bid up these shares for current investors to make real money.
