October 28, 2011

Groupon’s road to IPO: Best resources for potential investors

Filed under: daily deals, groupon — Rakesh Agrawal @ 12:14 am

This is a compilation of the best news coverage I see of the Groupon IPO. I won’t be including items from this blog on the list, but will include my work elsewhere.

Other sources:

My work on VentureBeat:

If you represent an institutional investor and would like to schedule time with me, please contact Pacific Crest Securities.

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October 27, 2011

My video analysis of the Groupon roadshow

Filed under: daily deals, groupon — Rakesh Agrawal @ 5:04 pm

On Tuesday, I led a live viewing of the Groupon IPO roadshow video on Chill, a great new site for interacting with others while watching video.

The video below includes my analysis of the Groupon roadshow, as well as my answers to audience questions.

My apologies for the hostage-taker video quality. I was serving as a one-man camera host, man, director, producer and editor. Clearly my friends at Bloomberg TV and CNBC have nothing to worry about.

Also check out my annotated version of the Groupon roadshow video.

Institutional investors looking to speak with me should contact Pacific Crest Securities.

A big thank you to my friends Brian Norgard and Andrew Skotzko for hosting the even.

Groupon’s tricky S-1 math

Filed under: daily deals, groupon — Rakesh Agrawal @ 7:44 am

Quick: How many people bought a Groupon in the third quarter?

The obvious, easy answer based on the latest S-1 is 29.5 million. That’s what Reuters wrote yesterday. (They rounded up to 30 million.) But that number is wrong.

What Groupon reports in their S-1 (in their quarterly results)  is how many people have ever bought a Groupon. Because it is listed in the quarterly section, someone who is not deeply studying the S-1 would assume that that is how many were sold in the quarter. Groupon intermingles quarterly results and cumulative results in the same column.

This is just one of the many tricks used by Groupon to hide data.

This method of reporting would hide sequential declines in actual purchasers of Groupon during the quarter. It’ possible that fewer people purchased a Groupon during the the third quarter than the second quarter. But we don’t know, because Groupon doesn’t tell us.

At times, reading the Groupon S-1 is like solving a GMAT data sufficiency problem. Do I have enough data points to find this information?

So how many people did actually purchase Groupons during 3Q?

  1. We know that the number of people who have ever purchased Groupons increased by 6.4 million from 2Q to 3Q. So at least 6.4 million people purchased Groupons in 3Q. That would imply that no one who had ever purchased a Groupon before purchased one in 3Q. So that number is clearly too low.
  2. We know that as of 3Q, 29.5 million had ever purchased a Groupon. If everyone who had ever purchased a Groupon bought one in 3Q, that would mean 29.5 million purchased one. That’s the number Reuters reported. Clearly that number is too high.
  3. We know that between 2Q and 3Q the number of repeat purchasers increased by 4 million. These are people who had purchased only one Groupon before and then purchased another one, making them a repeat purchaser.

Putting all that together, if you take the number of people who were new purchasers of Groupons (6.4 million) and add in the increase in the number of repeat purchasers (4 million), you end up with 10.4 million.

That number is also high because new customers who bought more than one Groupon in 3Q would be double counted. We don’t know how many of those there were.

But it’s low because some proportion of people who were already repeat customers in 2Q would also have been repeat customers in 3Q. If we assume that 60% of repeat customers in 2Q bought in 3Q, that’s another 7.2 million. (We don’t know what that proportion is; this is an estimate.) Adding that in, we get 17.6 million.

Is that number exactly right? No, but it’s a better number than the 29.5 million. (The biggest variable is what proportion of 2Q repeat customers repeated in 3Q.)

Groupon could easily report the number of customers who purchased a Groupon in a given quarter.

So why doesn’t it? It’s material information. The fact that the company goes out of its way to hide information like this should be a big red flag.

October 24, 2011

Think Groupon is a technology company? Think again.

Filed under: daily deals, groupon — Rakesh Agrawal @ 6:08 pm

Through much of its roadshow presentation, Groupon tries to make the claim that it’s a technology company. At one point, CEO Andrew Mason bizarrely uses a cyborg to illustrate how much the company is about technology. From a company perspective, that makes sense: technology companies get much higher valuations than other companies. But investors should think twice.

Here’s why:

Only about 5% of Groupon employees are in technology.

Only about 5% of Groupon employees are in technology.

According to Groupon’s latest S-1, only 5% of Groupon’s more than 10,000 employees are in technology. That ranks below “Unspecified.” The only group within the company that is smaller is city planners, who are responsible for scheduling deals.

To make matters worse, earning additional revenue requires a corresponding increase in employees. The size of departments such as editorial, sales, merchant services and customer service should grow in line with revenue increases. In its third quarter, revenues grew 9.6% and overall headcount grew 8.2%.

The company is already more than three times the size of Facebook in terms of employees.

Although two of the executives in the roadshow presentation tout their Amazon credentials, comparing Groupon to Amazon is a big insult to Amazon. The latter has invested in core technologies and infrastructure that have become the core of many Internet sites, including EC2 and S3. Although others invented cloud competing, Amazon has done more than anyone else to democratize and popularize it. Amazon invented Kindle and made e-books mainstream. It continues to innovate in supply chain and logistics.

Besides, the core problem in local is not a technology problem: It’s the reluctance of many small businesses to use Internet technologies. That’s a problem hundreds (if not thousands) of companies have wrestled with for 15 years now. Many companies have built self-serve platforms that few businesses used. Groupon’s innovation was to strip away the requirement for the business to use a computer, make Internet advertising less targeted, less efficient and more expensive — expensive enough that it could afford to pay a sales force.

But that’s a bridge at best. Eventually, probably in 3-5 years, businesses will use the Internet more for marketing. Once that problem is solved, real technology companies with massive built in distribution like Google and Facebook will dominate the space.

There are some technology intensive problems in local, such as mapping, routing and imagery. But those are mostly being tackled by Google and Microsoft; other companies (including Groupon) incorporate them in to their own products through APIs.

As further evidence of its technology expertise, Groupon touts its SmartDeals targeting engine.

I’ll believe that they’ve invented a great targeting engine when I stop getting deals for mani-pedis and The Body Shop.

October 23, 2011

Short-term, transactional thinking in a social media world

Filed under: strategy, travel — Rakesh Agrawal @ 4:35 pm
$7.60 bottle of water

$7.60 bottle of water

I woke up this morning to find a bill under my door for a $7.60 bottle of water, courtesy of the Palace Hotel in San Francisco.

Apparently the bottle of water next to the bathroom sink wasn’t free. There wasn’t any sign near the bottle that indicated that there was a charge.

I travel a lot and as an elite member in Starwood’s loyalty program. I often get free bottles of water, fruit, wine and other goodies. When water has a charge, there’s usually a hang tag on the bottle.

It turns out that there was a sign – but it was next to the TV. It said, “As a luxury service, Voss bottled water is available in your room. A seven dollar charge ($7) for each bottle consumed will appear on your guest folio.”

This tells me two things: 1) At some point they swapped out the higher end Voss bottled water for some generic stuff and this “luxury” hotel couldn’t be bothered to update the signage. 2) They don’t feel the need to be upfront about their pricing.

I don’t mean to pick on Starwood here. This happens at a lot of hotels. I sometimes don’t notice this stuff until I get my credit card statement. It’s usually not worth the trouble to call and complain and get a refund. But it does eat at me and annoy me. The last thing I’ll remember about your hotel is that you screwed me out of $8. Is that really worth it? Is that the impression you want to leave for someone who spent hundreds of dollars at your hotel?

Airlines are some of the most transactional companies out there. I’ve flown United (and Continental) extensively since 1999. A major reason that I’ve stuck with United for the last six years is that elite members have free access to Economy Plus seating with more legroom. Starting next year, lower tier elite members won’t be able to reserve the seats until check in. Someone at United decided that they could make more money selling the Economy Plus seats and only offering the ones that they can’t sell to lower tier elite members.

Instead of rewarding loyalty, they decided to generate short-term revenue. My response: I will shift as much of my flying to Virgin America as possible. I’d rather have an overall higher quality experience flying Virgin than take a chance stuck in some tiny seat on United flights. Not only will United not get any money from me for the better seat, they won’t get any fare revenue either.

Transactional thinking is all around us. This includes things like roaming charges on cell phone bills which can lead to bills for thousands of dollars, bank fees, rental car charges and Groupons where you get to the hotel and find out you owe an extra $100 because tax wasn’t included in the price you paid.

Transactional thinking also applies to people. Recruiters are a case in point. Many recruiters in Silicon Valley are transactional. I get a lot of calls from recruiters and many of them are solely focused on the current placement. I have talked to many who clearly don’t understand my skills and interests and push me to apply for roles that I’d be ill-suited for. This might help them earn a placement fee in the short term, but it isn’t good for me or the company.

Two of my favorite recruiters in Silicon Valley are Sara Huth and Stuart Liroff. Neither has ever placed me. But we have ongoing conversations. They take the time to know my interests and capabilities. We follow each other on Twitter and Facebook. They’re happy to refer me to others in their network, even though they don’t immediately benefit from it. And I’ll happily refer great people I know to them.

One of my new favorite people in Silicon Valley is Semil Shah. Every time I see him, he asks “How can I help?” And unlike many people, he genuinely means it.

Transactional thinking becomes even more dangerous in a world of social media, where consumers suddenly have a megaphone. Instead of just telling their immediate friends, they can tell the whole world. Social media can aggregate, amplify and empower. A single person who doesn’t like what your company is doing can use social media to significantly affect it.

At a grander scale, we’re seeing that play out with Bank of America’s $5 debit card fee. That fee was one of the catalysts for the Occupy Wall Street movement.

It’s easy to model the short-term revenue impact of new fees and other customer-unfriendly policies. But the power of pissed off customers is hard to put into a spreadsheet.

Update: When I went to check out, it turned out there were two bottles of water charged to my room. I only drank one. It turns out there were supposed to be both Voss water bottles ($7 each) and generic water bottles (free). But I never saw any Voss bottles and was charged for two. So in a best case scenario, there are different types of water and one is free and the other is not. How confusing is that? In the end, they removed the charges.

A note about my Groupon coverage and accountability

Filed under: daily deals, groupon — Rakesh Agrawal @ 1:00 am

I’m sometimes asked if I ghost write under other names or post comments anonymously about Groupon. I do not. Everything I’ve written about Groupon and the daily deals space has been posted under my name.

I do, however, answer a lot of calls from other reporters about Groupon and the daily deals space. I help them to understand how the space operates and to interpret financial statements. I also help make introductions to other sources they might want to contact or businesses they might want to interview. I sometimes advise reporters on what questions they should ask.

In many cases, I’m quoted by name. But in a lot of cases, my comments are paraphrased, summarized or woven into the structure or theme of the story. This is at the discretion of the reporter; I do not ask for my comments to be on background.

October 21, 2011

Like many Groupons, Groupon is no bargain — even at 50% off

Filed under: daily deals, groupon — Rakesh Agrawal @ 2:20 pm

Groupon finally announced the details of its much awaited IPO. The company seeks a valuation that is between 1/3 and 1/2 of what was rumored when its first S-1 was published in June.

Although the numbers are on the surface much better than we’ve seen before, this was primarily the result of Groupon significantly reducing its marketing expenses. The structure of the company’s business is that marketing expenses can be ramped up or down to achieve company objectives: if the company desires hypergrowth, it can achieve it by spending aggressively on marketing. If it desires to veer toward profitability, it can cut marketing expenses. It seems to have done exactly that. Groupon has done a great job of dressing up the pig for the State Fair. But it’s still a pig.

That does not change the fundamentals of Groupon’s business. Cutting marketing substantially hurt Groupon’s growth. Among the key numbers that trouble me:

  • Sequential growth in merchants featured dropped from 38.2% in 2Q to 0.2% in 3Q. A drop of 38 percentage points.
  • Sequential growth in Groupons sold dropped from 15.8% to 1.5%. A drop of 14.3 percentage points.
  • Average revenue per subscriber dropped from $3.90 to $3.30, a drop of 15.4%

Groupon’s revenue share declining
The percentage of revenue that Groupon gets to keep from a deal also dropped substantially — from 42% in Q2 to 37% in Q3. Long term, I expect this number to be in the 10-20% range.

Groupon explains part of this with:

We launched several new channels including travel (Groupon Getaways), event tickets (Groupon Live) and consumer products (Groupon Goods). These new channels had lower deal margins than our standard featured daily deals. Over time, we expect our deal margins in these new channels to improve.

Groupon does not provide any reasoning for why it expects margins on these deals to improve. Unless Groupon is currently subsidizing these deals, this is the equivalent of saying that the margin fairy will arrive to help them out. Travel, ticketing and consumer goods are well established categories. Merchants in these categories have a lot of experience in online commerce. They know the margins they will accept and how much they will pay for advertising. To them, Groupon is just another channel that needs to compete with SEO, SEM, display and their other established advertising channels.

Declines in established markets

In more established markets, the number of Groupons sold in the quarter dropped on a sequential basis. In Chicago the drop was 11%, Boston 10% and Berlin 4%. That’s not a drop in growth, it’s an actual drop. Groupon does not provide details on revenue in each market, so it’s unclear what the revenue impact of these declines is. But it’s not a good sign for investors that long established markets are buying fewer and fewer Groupons.

Groupon’s merchant pool in North America declined for the second consecutive quarter. This is the pipeline of potential merchants for Groupon to feature. As word spreads of the terrible economics of running Groupons for merchants, I would expect this number to continue to decline.

Accounting changes

Following Groupon’s accounting is like playing whack-a-mole. Every time you think you’ve got the mole, it shows up in another hole. In yet another change to its accounting practices, Groupon substantially redefined what it includes in cost of revenue. I had previously pointed out that Groupon’s cost of revenue was soaring. From the first half of 2010 to the first half of 2011, it increased 40% on a percentage basis. I also said that this would be an important metric to follow to judge the risk inherent in the “Groupon Promise.” (I had asked Groupon PR to comment on that.) I believe that the Groupon Promise still represents a significant risk to investors. But under the new definition, that number is obfuscated.

An important related issue is that Groupon’s auditors, Ernst & Young, keep going along with such changes. There’s no reason that such significant changes to the company’s financials should be made weeks before the IPO. It reflects poorly on both Groupon’s CFO and Ernst & Young.

Other bad signs

  • The proportion of subscribers who have ever purchased anything from Groupon remains stuck near 20%.
  • The cost of a new subscriber in 3Q was $6.67.
  • The cost of a new customer in 3Q was $28.15.
  • Only 54% of Groupon customers have purchased more than one Groupon. Based on the company’s financials, I’m one of Groupon’s best customers.

The only good sign that I see in this offering is that the money raised will actually go to the company, instead of into the pockets of Groupon insiders. Groupon will raise roughly half of what it has raised in previous rounds, but the company will get nearly 4 times what it got before.

That cash infusion may give the company enough time to find a real business model.

October 14, 2011

Groupon and LivingSocial get half off deals they won’t like: their traffic

Filed under: daily deals, groupon, livingsocial — Rakesh Agrawal @ 8:21 am

Traffic to leading daily deal sites Groupon and LivingSocial has fallen often a cliff in the last few months, according to data from Compete.

Groupon visitors have plummeted more than 50% since June.

Since June, unique visitors to Groupon have fallen more than 50% from 33.7 million to 15.8 million. In the same period, LivingSocial’s unique visitors have fallen from 14.7 million to 7 million. Just in the last month, Groupon visitors are down 28%. LivingSocial’s visitors were down 32% in the last month.

LivingSocial traffic has also fallen more than 50% since June.

LivingSocial spokesman Andrew Weinstein responded, “There are a lot of competing and contradictory estimates out there, but they should all be treated with deep skepticism, as none are based on our actual numbers.” Groupon did not respond to a request for comment.

Although Web metrics generally vary depending on the source of the data, I’m comfortable using comparisons from within the same data source for relative changes. The magnitude of the drops indicate that this isn’t a statistical anomaly. This also comes during a period when LivingSocial ran an expensive publicity stunt with Whole Foods to drum up user interest.

I asked Compete about any methodology changes during that time that could have resulted in the large drop. I have not yet received a response. However, during the same period,  Amazon was up 4%, eBay was up 3% and Google was up 5%.

Compete’s data are based on a panel of 2 million people in the United States. According to Groupon’s S-1, its North America segment accounted for 42% of revenue for the six months ending in June.

Groupon’s management has repeatedly claimed that prospective investors should ignore the company’s high customer acquisition costs because once they acquire a customer, that customer will keep coming back and can be marketed to again at no cost.

These data suggest otherwise.

I’ve argued repeatedly that Groupon should disclose email open rates in its S-1. The Compete data says that traffic is falling rapidly.

Given that email is a core part of Groupon’s business, if Groupon knows that people aren’t opening its messages, that is material information that investors deserve to know.

October 10, 2011

Why I agree 100% with Groupon on obfuscating its Deal Counter numbers

Filed under: daily deals, groupon, livingsocial — Rakesh Agrawal @ 5:11 pm

Groupon announced on its blog yesterday that it’s going to obfuscate the numbers shown in its Deal Counter, which shows how many of each deal sold. It’s the right move for Groupon.

I noticed this in action several weeks ago when I looked at a few deals. I didn’t write about it because it didn’t seem like a big deal to me. Groupon is just preventing competitors from getting competitive intelligence on its business and the media from jumping to inaccurate conclusions based on faulty interpretation of data collected by third parties like Yipit.

A tipping point for this likely was all of the crappy coverage around Yipit’s revenue data claiming that LivingSocial’s revenue grew five times faster than Groupon’s in September.

That makes for a great headline and it’s technically true. But in every meaningful way, it’s not true.

Unfortunately, too many journalists don’t know the nuances of statistics and the intricacies of the business models behind the companies. TechCrunch got it mostly right in the details of its story, but the headline was largely linkbait.

There are two fundamental problems with the 5X number:

  • LivingSocial’s September revenue growth was largely driven by the Whole Foods deal, a deal in which I believe LivingSocial sold Whole Foods gift cards for about half what they paid for them. Of course people  bought it! It doesn’t reflect the fundamental value of the LivingSocial product. If you back that out, LivingSocial’s growth rate drops from 32% to less than 10%.
  • It’s harder to grow percentage wise when you’re a lot bigger to begin with. Groupon’s August revenues were 3x that of LivingSocial’s. In actual dollar terms, a 1% growth in Groupon’s revenue is equivalent to a 3% growth in LivingSocial’s revenue. If you believe in the Daily Deals space*, Groupon is unquestionably the better company.

Beyond the problems with the number itself, there is the fact that Gross Revenue Numbers Don’t Matter.

This is a problem that I’ve been harping on for more than four months. I even cited selling cash equivalents for half of cost as a potential problem. Reporting gross revenue encourages the kind of stupid revenue buying that LivingSocial has engaged in. The fact that media keep playing along with such tactics makes it even more worthwhile.

Groupon was recently forced by the SEC to restate its financials based on the amount of revenue it gets to keep, not what it charges consumers. That’s what really matters.

If LivingSocial booked revenue according to those same rules, it would have shown a reduction in revenue of $10 million due to the Whole Foods deal instead of an increase in revenue of $10 million. (More likely, they would have called it a marketing expense, booked $0 as revenue and $10 million towards marketing.)

Unfortunately, the media gravitate toward the Yipit numbers because they are the only numbers that are available. Groupon reports numbers only quarterly (or whenever CEO Andrew Mason feels like writing an email with unaudited numbers). As a private company, LivingSocial hasn’t reported any numbers other than vanity statistics.

Tying back to my piece on Groupon and incentives yesterday:

  • Media outlets have an incentive to write stories with big but bogus numbers because they generate clicks. LivingSocial sells 1 million in one day! LivingSocial growing 5x faster than Groupon! Groupon is the fastest growing company in history! etc.
  • Yipit has an incentive to publish data because it gets it name out there. I wasn’t privy to the conversations they had with journalists. I’ve met Yipit COO Jim Moran and I suspect that Yipit provided all of the right caveats, they just fell by the wayside as the story circulated. Unfortunately, Yipit isn’t in a position to provide better data — just to explain the constraints of their methodology.
  • Groupon has an incentive to stop putting out data that will be misused by people to make its business look worse than it is. Unfortunately for them, I suspect that people will just use the lower numbers because that’s what’s available and make the asterisk on the data’s validity slightly larger.
  • I have an incentive to not write about the other data I wouldn’t publish if I were in charge of Groupon because that data is helpful in my reporting and analysis.

*On the off chance that you haven’t read any of my previous analysis, this is by no means an endorsement.

October 9, 2011

Groupon, IPOs and incentives

Filed under: daily deals, groupon — Rakesh Agrawal @ 10:22 am

When I first started writing about Groupon more than four months ago, my friend Semil asked me “Why are you the only one saying these things?”

I explained that it call came down to incentives.

Consider the various people involved and what their incentives are:

Groupon insiders and investors. They own a substantial amount of Groupon stock. Obviously they have incentives to say good things about the company. In Groupon’s case, they’ve said substantially more than they should have. This includes Eric Lefkosky telling Bloomberg West’s Cory Johnson that the company would be “wildly profitable,” in violation of SEC quiet period rules. (A statement that was later retracted.) It also includes Andrew Mason’s extremely rosy email to employees that was “leaked” to the media.

Other startups looking to benefit from a frothy market. If Groupon were to have gone public with a valuation of $20 billion to $30 billion, it would have benefited other terrible companies looking to go public. This sentiment has shifted lately; I’ve heard more from VCs hoping that Groupon tanks because there are good companies out there and they don’t want a post-IPO disaster in Groupon to affect their strong companies.

Short sellers. Even if you think a company is the worst pile of shit ever known to man, your incentive is to keep your mouth shout. It’s better financially to wait for the company to go public and then either short the stock or buy puts against it. I’ve had shorts ask me to stop writing and talking about Groupon because I am reducing the maximum profit they can make betting against the company when it goes public. At a $30 billion valuation, Groupon is the short of a lifetime. At a $3 billion valuation, it’s probably still a good short, but there’s a lot less profit. Investor and analyst Paul Kedrosky says that institutional shorts are among the people most eager to see Groupon get out. He has also had people ask him to stop talking about Groupon. (See the video below.)

Partners. Groupon is still a big company with a lot of influence over the startup ecosystem. Partners and potential partners of Groupon have to say positive things about the company. But what they tell me in private is very different from what they say for attribution.

With all of that, you had a lot of people with incentives to say good things about Groupon.

The group that has the most incentive to accurately write about Groupon is the media. Unfortunately too many journalists (including business journalists) don’t understand the complexity of Groupon’s business model and the basics of economics and statistics. I’ve read a lot of really awful and inaccurate analysis by journalists.

Too many just blindly report what Groupon insiders tell them. My writing started after I read an incredibly glowing piece by a supposedly expert journalist. At the time, I knew that the company was worse than the picture he was painting; I didn’t know how bad it was. Only now are you starting to see the mainstream media tide turn against Groupon.

There is some great analysis out there, but by and large it hasn’t been in the mainstream media. Some of the best is on a blog called Grumpy Old Accountants.

In the print media, by far the best coverage on Groupon and the deals space has been by Doug MacMillan at Bloomberg Businessweek. On the TV side, Emily Chang and Cory Johnson have done a terrific job covering the story on Bloomberg West.

In terms of my own incentives, I have to admit that I sometimes question whether I did the wrong thing. I’ve invested a significant amount of time and money covering Groupon. Unlike professional reporters, I don’t get paid for what I write. My expenses (such as my trip to visit Groupon in Chicago) come out of my pocket. Financially, I would have been much better off waiting for Groupon to go public and shorting it.

There are times when I’m up at 3 a.m. doing analysis and I think “Why do I keep doing this?” The best answer I can come up with is I don’t want more small businesses to get fleeced. And that as much as I study the incentives of others, I suck at responding to my own incentives.

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