Groupon stock soars on first day

November 5, 2011

Tony Arnold and The Associated Press

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(Getty/Scott Olson)
Despite a successful IPO and a 31% increase in it's stock price, many analysts question Groupon's long-term prospects.

Groupon's stock sizzled in its public debut Friday despite concerns about its accounting practices ahead of an initial public offering and doubts about the viability of its business model.

Groupon ended the day up 31 percent from its starting price. That means it would cost a trader more than $26 for a single share of the daily deal website.  At one point during the day, the stock traded at $31 per share.

Groupon launched its initial public offering on the NASDAQ exchange with an opening price of $20 per share, and some analysts were expecting the price to close between $16 and $18 per share at the end of trading.

"The conventional wisdom was that Groupon was an unsustainable business so the demand was a little bit of a surprise," said Greg Sterling, who analyzes the finances of web-based companies.

But not even a gain of about $4 billion in market value — to nearly $17 billion — could erase lingering questions about its long-term prospects. Groupon has faced scrutiny over its high marketing expenses and large workforce. Plus, there are now several competitors with similar products.

Sterling said it's hard to say how Groupon will fare on the stock market in the future since the company had a bumpy road to go public in the first place.

Groupon breaks ice for others

Bigger than IPOs for Internet radio company Pandora Inc. and professional network LinkedIn Corp., Groupon's debut served as an icebreaker for a frozen IPO market.

It further sets the stage for the public debut of online game company Zynga Inc., which is expected in the next few weeks. It'll culminate next year, with the expected IPO of Facebook, one dwarfing them all.

Still, analysts remain worried about the risks concerning the company, especially as the stock price increases.

"Until investors see the full profit model unfold over time, expect this stock to be highly volatile," said Kathleen Shelton Smith, principal of Renaissance Capital, which operates IPOhome.com. "The first day of trading is typically more about supply and demand. Fundamentals will take over in the long run."

Groupon makes money by sending out frequent emails to subscribers offering a chance to buy discount deals for anything from laser hair removal to weekend getaways. The company takes a cut of what people pay and gives the rest to the merchant.

Because the model is easy to replicate, it has spawned many copycats after its 2008 launch, from startups such as LivingSocial to established companies such as Google Inc. and Amazon.com Inc. (which incidentally runs its deals through LivingSocial).

Groupon has the advantage of being first. This has meant brand recognition and investor demand, as evidenced by its strong public debut.

Nonetheless, Chicago-based Groupon Inc. has faced scrutiny about its high marketing expenses, enormous employee base and the way it accounted for revenue.

Groupon splits the money it collects from customers with merchants. But it reported all of its gross billings, not just the money it gets to keep, as revenue. After federal regulators questioned it, Groupon submitted new documents in September that showed that net revenue in the first half of this year was about half of what it originally reported.

Using the new accounting method, Groupon had revenue of $1.12 billion in the first nine months of the year. But it lost $308 million because of high operating expenses. The company spent $1.18 billion on such things as marketing to acquire new subscribers and running its business. Groupon went from 37 employees in June 2009 to 10,418 as of Sept. 30 this year.

By contrast, Google had revenue of $1.35 billion and net income of $143 million in the first six months of 2004 before going public that August. Other than its most recent quarter, LinkedIn has been profitable since last year.

A second Internet bubble?

For some longtime IPO watchers, Groupon's ascent is reminiscent of the late 1990s tech boom — and bust.

One reason for that is its low "float," meaning Groupon is selling just 5.5 percent of its available shares. Though not unprecedented, the amount is below that of many prominent tech companies, such as Google (7.2 percent), Amazon (12.6 percent) and LinkedIn (8.2 percent).

"The retail investors buying the stock, I don't think they were around in the 2000 dot-com bust. I don't think they have a historical perspective of what happens over time," said Francis Gaskins, president of IPOdesktop.com. "They are buying based on emotion."

There's pent-up demand not just for tech IPOs, but IPOs in general, especially from U.S. companies, said Josef Schuster, CEO and founder of IPOX Schuster, an investment firm that specializes in IPOs. And the pre-Thanksgiving offering was good timing for Groupon because it will benefit from the holiday shopping period, he added.

Still, he believes it's a risky investment in the long run.

"Groupon fits very well into a late 1990s IPO," he said, citing its low float, which helped drive up demand on opening day.

Thursday's pricing gave Groupon a market value of $12.7 billion, below only Google's among tech company IPOs. With Friday's stock price jump, Groupon's value rose to $16.58 billion.

Despite competition, Groupon still holds 'first-mover' advantages

Though critics abound, not everyone believes Groupon is a disaster waiting to happen.

"They have a real business. They can really make money. They have a really large first-mover advantage," Wedbush analyst Michael Pachter said. "The downside is that it's not hard to do what they do."

Still, he said, the fact that Google tried to buy them — in a $6 billion deal that Groupon rejected — instead of doing a deals business of its own should account for something (Google eventually started its own deals service called Offers). Amazon's deals service, meanwhile, are powered by LivingSocial, Groupon's smaller rival in which Amazon owns a stake. Facebook tried its hand at deals but killed it off in August after four months of testing.

Pachter sees some similarities between Google, a first-mover in the online search market, and Groupon. There have been a lot of online search copycats but Google remains king. And there are opportunities for Groupon, such as targeting its deals beyond geography, based on people's interests and demographic profiles.

Another Internet darling, professional networking service LinkedIn, saw its stock soar to $122.70 on its opening day in May after pricing at $45. It's back up now, at $82 — a possible pattern for Groupon in the coming months.

"I don't think from today's trading we can actually say what the long-term value of the company is," Pachter said. "Let's see what they do with the cash."

 
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