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.