The Bear Case for Groupon

Groupon Inc ($GRPN) disappointed investors yesterday by posting a fourth-quarter loss that caught analysts by surprise.

This was supposed to be Groupon’s big moment to silence all the critics and prove all the skeptics wrong, but it didn’t exactly work out that way.  During the fourth-quarter, Groupon posted a -$0.02 per share loss compared to the analyst’s low-ball expectations of $0.03 EPS for the quarter.

The surprising loss sent Groupon shares down as much as 15% and shined a big spotlight onto an already polarizing company.

Even though Groupon has generated $1.95B in revenue from 2009-2011, the company has still yet to generate any profit.  In fact, the company has actually generated losses of $689M during this time period.

When you are 3 years into a business and you have still yet to generate a single dollar of profit for your shareholders, it’s usually not a good sign.

You must also consider that the daily deals space is a hot market right now with a number of savvy competitors including LivingSocial, Google Deals, and deal aggregators like Yipit.  Although Groupon was a first mover in the daily deals market, they still have generated no profit from their dominant market position and it’s not getting any better.

During the fourth-quarter, Groupon generated a paltry 3% profit margin and if this trend continues the company could be in trouble from a balance sheet perspective.

If you’re a high growth company… there are two ways to finance your growth:  fund it through retained earnings or fund it through the capital markets.  Since Groupon continues to operate at a loss, the company is unable to retain any profits and they are actually depleting their retained earnings.

As of Q4 2011, Groupon’s cash balance was $1.12B, however, given the unsustainable cost structure at the company, this cash balance could become a concern sooner than later.

So what’s the next option for Groupon? The company will need to either sell more shares (thus diluting existing shareholders) or tap the capital markets and take on some debt.

For a company that just went public and reaped a huge cash windfall from their IPO, it’s somewhat disconcerting that cash is already a concern at this relatively early stage in the game.

Another big challenge for Groupon for is maintaining a laser focus on managing their expenses, which are completely out of control.

 

To be completely blunt:  Groupon has done a terrible job managing their expenses through the years.  If you want to compete in a low margin sector like the daily deals market, you need to operate with strict fiscal discipline, which is clearly lacking at Groupon.

This subject is pretty close to me because I worked as a Budgeting, Planning, and Forecasting analyst at Intel where I scrutinized every single expense line-item each month.  Even though Intel had plenty of cash and a a great position in the market, I was on the front lines trying to ensure that costs were in-line on a daily basis.

When I saw a weird expense that looked questionable, I wasn’t afraid to ask questions about it.  Sometimes this meant trying to cut down on travel expenses or setting strict standards regarding discretionary purchases within the department.  This fiscal discipline really paid off because it ensured that folks in my department were honest and transparent about their expenses.

For a budgeting analyst, it’s pretty easy to look at a budget and know when it’s in line or not… I have studied this company closely and Groupon’s expense control raises big red flags in my mind. It’s easy to pick apart a company when several expense line items are greater than their annual revenues.

Headcount is another important topic because employees are a very important cost that you must take into consideration.  From a headcount perspective, Groupon is even more staggering when you dig into the numbers.  As of August 2011, when they filed their S1 registration statement with the SEC, Groupon had a mind-boggling 9625 full-time employees.

Think that’s bad enough? Andrew Mason, Groupon’s CEO, actually talked about their plans to hire more engineering talent.  So even though Groupon’s cost structure is already extremely sub-optimal and racking up huge losses for shareholders, their chief executive wants to actually add more employees to the company.   Talk about a hiring binge.

Groupon CEO Andrew Mason is an eccentric guy, as evidenced by the bizarre videos on Groupon's blog that show him doing various yoga poses. However, his managerial and financial decisions are even more head-scratching.

Personally, I would stay very far away from this company until there are some positive improvements on expense control, margins, and profitability.  If Groupon wants to make it in this sector, they will need to exercise better internal controls regarding expense control and profitability metrics.

The company has built a great product and has the revenues to show for it, but their reckless attitude towards managing the financials will come back to haunt them sooner than later if they don’t change their philosophy.

When you consider Groupon’s management team in place and the stiff competition, I have some serious doubts whether they can turn this thing around.


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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