reDesign

March 31, 2012

Why Groupon is poised for collapse — an update

Filed under: daily deals, groupon — Rakesh Agrawal @ 6:39 am

Groupon was forced to restate fourth quarter earnings, sending its stock down 6% in after-hours trading. This surprised me as much as my $2 investment in the Mega Millions jackpot not paying off.

The reasons for Groupon’s restatement were higher refund reserves and weakness in internal controls. These are issues I’ve repeatedly discussed. I raised them directly with Groupon PR in September (back when they still would speak to me) and I was assured that refunds weren’t an issue for Groupon.

I also spoke with a former Groupon salesperson who claimed he was fired because he raised concerns about poor internal systems that didn’t track deals correctly and complaints about poor risk management when it comes to running deals.

So what’s happening at the coupon company?

Well, for starters, it’s not a coupon company nor a marketing company. At its core, Groupon’s U.S. business is a receivables factoring business, as I wrote last year. They give loans to small businesses at a very steep rate (the price of the discount plus Groupon’s commission). They get the money to fund these loans from credit card companies such as Chase Paymentech. Groupon is essentially a sub-prime lender that does zero risk assessment. And as word continues to spread about what a terrible deal running a Groupon is for many categories of businesses, the ones that will choose to run Groupons are the ones that are the most desperate. For U.S. based businesses, the only time I can definitely recommend running a Groupon is if it is otherwise going to go out of business.

Another factor is that Groupon is selling bigger and bigger deals and many of these have requirements for use. Some deals have medical qualifications. The former salesperson told me about Groupons for a procedure called “cool sculpting”. In this procedure, fat is frozen off the body. In order to get the treatment, patients must be medically qualified. But Groupon has no way of medically qualifying purchasers and will sell it to anyone. When they go to the doctor and find out that they aren’t eligible, they call Groupon for a refund. If this is several months later, after Groupon has paid out the entirety of what it owes the provider, this can mean a refund loss for Groupon.

Travel is another risky category for Groupon. Unlike Expedia, Travelocity, Priceline, Jetsetter and nearly every other major travel provider, Groupon does not require consumers to pick their dates and confirm availability at the time of purchase. When a consumer finds he can’t use his Groupon months later, he calls for a refund. Groupon also hides material restrictions on travel deals, something I pointed out in September and Groupon still hasn’t rectified.

Because these are higher ticket items that cost hundreds or thousands of dollars, consumers are more likely to ask for a refund than on lower ticket items. In the short term, it means a revenue boost to Groupon, which the company needs as its once torrid growth itself cools. In the long term, it means refund losses.

The “Groupon Promise” is another risk factor. It’s an overly broad promise designed to allay consumers’ concern about using Groupons. Because it is so broad, it results in higher refund rates than would otherwise be the case.

Yet another concern is that Groupon does not track how much outstanding Groupon “debt” there is. There is no one in the world who can tell you how many and how much Groupon value is outstanding. Unlike typical gift card sales, Groupon books revenue immediately and then does not show the Groupons on its balance sheet. By my estimates, Groupon has between $500 million and $750 million in liabilities that it doesn’t show on its balance sheet.

In theory, Groupon’s exposure to that risk is covered by its refund reserves — but we don’t know the size of those reserves. And as yesterday’s restatement shows, they’ve calculated them poorly. Unless Groupon begins to do risk assessment on deals before they run, changes its payout terms to businesses or drastically changes its refund policies, I expect refund rates to continue to rise. If they do any of those things, I expect revenue declines because it will make running Groupons less attractive to businesses and buying Groupons less attractive to consumers.

Groupon has also worked hard to hide their refund rates. While going through their S-1 process last year, Groupon continually revised its accounting. At one point, I discovered a way to calculate their refund rates and found that refund rates had likely increased more than 40% year-over-year. In the next amendment to their S-1, they changed their accounting again to bury that data.

Investors should also be concerned about the fact that Groupon’s lock up should end in early May, releasing a lot more shares on to the market. I wouldn’t be surprised to see Groupon trading in single digits after that and heading to zero within the next 36 months. Groupon’s best bet is if they can acquire their way into a sustainable business model; I’m doubtful that will happen considering the companies they have purchased to date.

With its restatement, Groupon said that its guidance for the first quarter remained the same as earlier. Given that their lockup should end shortly before they report first quarter results, I would take that assessment with a mine full of salt.

See some of my previous writings on Groupon:

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20 Comments »

  1. Hi Rocky, just came across your blog from reading your guest post on VentureBeat. I was wondering what you think of Social Passport which was recently written up on Techcrunch (link here http://tcrn.ch/SPtechcrunch) and offers local businesses an affordable and repeatable marketing solution to drive incremental foot traffic. We don’t charge commissions nor have discount minimums, and turn marketing to one into marketing to many.

    Comment by Jon — March 31, 2012 @ 8:32 pm

  2. Rocky

    Just read the VB story on Groupon. Have you looked at or understand the implications to Groupon, specifically its cash, from escheatment laws? I seem to recall that unused gift card balances technically belong to the state after 5 years…not the card issuer (Groupon) or the merchant. I don’t really follow Groupon but the company’s “narrative” seems troublesome. If these groupons are sold, not refunded, nor redeemed, whose money is that? I can’t imagine it is working capital….just curious

    Comment by naheeshc — March 31, 2012 @ 8:53 pm

  3. [...] taking Groupon to task for the bazillionth time, I got a call from Andrew Mason. This was shocking because Groupon PR has kept me from talking to [...]

    Pingback by Why I’m joining Groupon « reDesign — April 1, 2012 @ 12:39 am

  4. Rocky, great analysis on Groupon. Quick question: in the case of refunds e.g., travel deals, why is groupon not able to cover the refund risk by going after the sellers. For example if a deal was bought by buyer on a travel deal and the buyer refunds it because he couldn’t find the travel dates he was looking for, in this case, seller has not really sold anything. And even if Groupon has paid to the seller, groupon is entitled to get that refund back from the seller.

    Thanks,
    Ishita

    Comment by Ishita — April 1, 2012 @ 10:37 am

  5. [...] Why Groupon is poised for collapse — an update « reDesign. [...]

    Pingback by The Short Analyst » Why Groupon is poised for collapse — an update « reDesign — April 1, 2012 @ 2:15 pm

  6. [...] Why Groupon is poised for collapse — an update « reDesign Browsing: Home » 2012 » April » 02 » Stream of consciousness [...]

    Pingback by Stream of consciousness April 2nd — April 2, 2012 @ 12:12 am

  7. [...] in a recent blog post, Why Groupon is poised for collapse wrote: Well, for starters, it’s not a coupon company nor a marketing company. At its core, [...]

    Pingback by SEC maybe investigating Groupon. Oops! — Tech News and Analysis — April 2, 2012 @ 7:18 pm

  8. [...] in a recent blog post, Why Groupon is poised for collapse wrote: Well, for starters, it’s not a coupon company nor a marketing company. At its core, [...]

    Pingback by SEC may start Groupon investigation | TechDiem.com — April 2, 2012 @ 9:34 pm

  9. Very interesting topic; pushing the logic a little further, I am wondering about the behaviour of Groupon’ stocks. Indeed, we’re talking of a company lending money to small businesses, and funding itself by selling coupons that might potentially be called for refund. A very peculiar configuration indeed, because of the unpredictability of the funding durations. That resembles somehow to the negative convexity attached to Asset Backed Securities, where the ‘accelaration’ of losses is greater that that of gains; that being said, it could as well be the other way around ;-)

    Comment by Bruno — April 3, 2012 @ 1:10 am

  10. [...] in a recent blog post, Why Groupon is poised for collapse wrote: Well, for starters, it’s not a coupon company nor a marketing company. At its core, [...]

    Pingback by GIASTAR – Storie di ordinaria tecnologia » Blog Archive » SEC may start Groupon investigation — April 3, 2012 @ 2:05 am

  11. [...] in a recent blog post, Why Groupon is poised for collapse wrote: Well, for starters, it’s not a coupon company nor a marketing company. At its core, [...]

    Pingback by Groupon: An SEC Investigation & A Sinking Ship : Two Letter Worlds — April 3, 2012 @ 2:12 am

  12. [...] állja meg a helyét. Rocky Agarwal eelemző már az elejétől követi a Groupon működését, ő hozza fel az egyik ajánlatot példaként. Az ajánlat szerint fagyasztással csökkentik a páciensben a [...]

    Pingback by A tőzsdefelügyelet vizsgálná a Groupont | magyarinfo.co.ukmagyarinfo.co.uk — April 3, 2012 @ 2:32 am

  13. [...] terms to the merchants, including upfront payments. This means turning a daily deals company into a receivables factoring business. But this may not necessarily be the future of the daily deals industry in Eastern Europe for the [...]

    Pingback by Where is Eastern European daily deals industry going? — April 3, 2012 @ 6:25 am

  14. [...] Agrawal estimates that there are currently between $500 million and $750 million worth of outstanding Groupo…. [...]

    Pingback by The deal may be off for Groupon, analysts warn | Best Articles And News — April 3, 2012 @ 6:47 pm

  15. [...] Groupon is essentially a sub-prime lender that does zero risk assessment | reDesign Well, for starters, it’s not a coupon company nor a marketing company. At its core, Groupon’s U.S. business is a receivables factoring business, as I wrote last year. They give loans to small businesses at a very steep rate (the price of the discount plus Groupon’s commission). They get the money to fund these loans from credit card companies such as Chase Paymentech. Groupon is essentially a sub-prime lender that does zero risk assessment. And as word continues to spread about what a terrible deal running a Groupon is for many categories of businesses, the ones that will choose to run Groupons are the ones that are the most desperate. For U.S. based businesses, the only time I can definitely recommend running a Groupon is if it is otherwise going to go out of business. [...]

    Pingback by This company is the opposite of “do no evil"– Groupon « The Bankwatch — April 3, 2012 @ 8:18 pm

  16. [...] Groupon is essentially a sub-prime lender that does zero risk assessment | reDesign Well, for starters, it’s not a coupon company nor a marketing company. At its core, Groupon’s U.S. business is a receivables factoring business, as I wrote last year. They give loans to small businesses at a very steep rate (the price of the discount plus Groupon’s commission). They get the money to fund these loans from credit card companies such as Chase Paymentech. Groupon is essentially a sub-prime lender that does zero risk assessment. And as word continues to spread about what a terrible deal running a Groupon is for many categories of businesses, the ones that will choose to run Groupons are the ones that are the most desperate. For U.S. based businesses, the only time I can definitely recommend running a Groupon is if it is otherwise going to go out of business. [...]

    Pingback by This company is the opposite of “do no evil"– Groupon | thenewsfinder.com — April 4, 2012 @ 1:01 am

  17. Is it ethical (or absurd) that Rocky Agrawal is now criticizing / attacking Groupon while simultaneously owning a short financial position?…

    It might be unethical or absurd if I started doing so after I obtained my short position. (I don’t believe that to be the case, but one would have a stronger argument.) But anyone who has been following my work knows that I think it is a terrible comp…

    Trackback by Quora — April 5, 2012 @ 2:20 pm

  18. [...] Why Groupon is poised for collapse — an update « reDesign Travel is another risky category for Groupon. Unlike Expedia, Travelocity, Priceline, Jetsetter and nearly every other major travel provider, Groupon does not require consumers to pick their dates and confirm availability at the time of purchase. When a consumer finds he can’t use his Groupon months later, he calls for a refund. Groupon also hides material restrictions on travel deals , something I pointed out in September and Groupon still hasn’t rectified. [...]

    Pingback by Startups | Pearltrees — April 9, 2012 @ 2:05 am

  19. [...] At the time, I suggested that one way Groupon could mitigate the risk would be to change its payment terms and move American merchants to the European model. [...]

    Pingback by The giant red flag that analysts and media missed in Groupon’s earnings | VentureBeat — August 15, 2012 @ 9:19 am

  20. [...] there is no guarantee that moving Web based would’ve saved them. Many of the deal sites are struggling as well. Consumers are over it and many businesses have been burned by the group coupon [...]

    Pingback by Did Group Deal Websites Kill the Entertainment Book? « — March 13, 2013 @ 8:37 am


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