Technology

Groupon's Stumbles May Force Company to Pare Back Size of IPO


(Bloomberg)—Groupon Inc., the largest online-coupon site, may have to settle for a smaller initial public offering as management gaffes, restated results and regulatory scrutiny leave investors leery of owning the stock.

The valuation might need to drop to as low as $3 billion to $5 billion to entice shareholders, said Josef Schuster, founder of IPOX Schuster LLC, which invests in IPOs. That’s a fraction of $25 billion that was said to be discussed as a potential valuation when Groupon met with underwriters earlier this year. It’s also below the $6 billion Google Inc. offered last year.

“Interest is diminishing by the week,” said Schuster, who manages $2.5 billion in assets for the Chicago-based fund. “All the news that’s coming out underlines some form of turmoil in the company. As an IPO investor, you don’t want that.”

The startup has drawn criticism for unusual accounting practices, rising marketing costs and the loss of two chief operating officers in six months. Combined with the stock market’s recent volatility, the events have made IPO investors wary of the deal, Schuster said.

Julie Mossler, a spokeswoman for Chicago-based Groupon, declined to comment on the company’s IPO plans.

The company has already postponed its IPO and pushed back meetings with investors due to stock-market swings, people familiar with the matter said last month. With investors more tepid on the company, it may have to delay the offering further, reduce the size or value, or pull it altogether, said Ryan Jacob, managing partner at Jacob Internet Fund.

Down to Earth

“The valuation may not be as high as some people optimistically thought a few months back,” Jacob said.

While Groupon has revised its prospectus to clarify accounting practices, the company hasn’t proved to investors that its business can keep growing and eventually turn a profit, Michael Cuggino, who helps manage about $15 billion at Permanent Portfolio Funds in San Francisco.

“I’m not quite sure the model is sustainable,” said Cuggino, who considered investing in Groupon but is less interested now. “The marketing costs and the costs of acquiring customers seem high. I’m not convinced that on a long-term basis the stores or vendors they are working with are going to stick around.”

The company makes money by selling discounts—known as Groupons—from businesses such as restaurants and nail salons. It then splits the revenue with the businesses.

Attracting Users

In a regulatory filing, Groupon said it’s having to spend more money to add users to its e-mail list. In 2010, the company spent $241.5 million to add 48.8 million subscribers, or about $4.95 per subscriber added. In the first half of this year, it spent $345.1 million to add 65.1 million subscribers, or about $5.30 for each one. That could be worrisome to investors, said Mark Fickes, a partner at law firm BraunHagey & Borden LLP in San Francisco.

“For a company that’s going public, that’s really important,” said Fickes, who previously worked at the Securities and Exchange Commission. “Investors are going to look at that and see that it’s getting more and more costly for the company to acquire that revenue.”

The company also restated 2010 sales to $312.9 million, down from a previous level of $713.4 million. In its earlier accounting, Groupon counted the total amount of its daily-deal sales as revenue, including fees paid to merchants. The company had already abandoned an operating-income approach that critics said masked Groupon’s true costs.

‘Wildly Profitable’

In July, Groupon updated its IPO filing, asking investors to disregard comments made the prior month by Chairman Eric Lefkofsky in a Bloomberg News story. In June, Lefkofsky had said, “Groupon is going to be wildly profitable.” The company said the statement doesn’t accurately or completely reflect his views.

Many companies have overcome gaffes to hold successful IPOs. Salesforce.com Inc.’s 2004 offering was delayed after Chief Executive Officer Marc Benioff disclosed information to the New York Times that wasn’t in filings. Google caused controversy that same year when founders Larry Page and Sergey Brin were quoted speaking to Playboy magazine during their quiet period, which the SEC requires before IPOs.

“There are very few IPOs that come down the pike that don’t have questions,” Ryan said.

While investors may look past out-of-school comments by executives, management turnover might give them pause. Margo Georgiadis left the company in September after five months as chief operating officer. Brad Williams, the former head of communications, and Rob Solomon, Georgiadis’s predecessor as operating chief, also left earlier this year after short stints.

Lack of Faith?

“You would expect that people wouldn’t be so quick to jump ship if they had more faith in the business model,” Cuggino said. “It is a potential indicator that the business model may have some holes in it that people discover once they join the company.”

Groupon also faces a bleak market for new stocks, with companies shelving IPOs at a record pace last quarter, according to data compiled by Bloomberg. That could make it more difficult for Groupon to lure investors, said Michael Binger, a fund manager at Thrivent Asset Management in Minneapolis.

“The sentiment of the market has changed from being optimistic to pessimistic,” said Binger, who said he would still consider investing in Groupon. “It’s a lot harder for a company to become public in a pessimistic market.”

If investors are reluctant to buy, Groupon may find itself wishing it had sold itself to Google last year, Binger said. Talks between the companies broke down in December after Groupon spurned the $6 billion bid.

“Groupon made a mistake in not accepting that offer,” he said. “Groupon would have been a very successful product within Google.”

MacMillan is a reporter for Bloomberg News and Bloomberg Businessweek in San Francisco.

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