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Groupon: A Tech Stock on the Brink of Collapse – Can It Survive?

August 04, 2012 | About:
Muhammad Bazil

Muhammad Bazil

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Groupon (NASDAQ: GRPN) runs a business that is perfectly legal but in my opinion, the entire business is managed with zero risk assessment and it lacks strong internal controls. Groupon is meant to serve a purpose really, as its shopping website shares attractive and relevant information with consumers and businesses worldwide on local goods and services. Groupon may appear like a marketing company but its core business model is quite different. Essentially, Groupon acts as a sub-prime lender to small businesses and then has them offer their goods and services at a bargain price. The bargain price is advertised to potential consumers and once enough people have signed on to the offer, the deal is completed. So, Groupon’s niche areas cover virtually everything including travel and medical.

Ordinarily, there is nothing wrong with Groupon’s core business model. Indeed, the company is a technology leader to some small businesses and local retailers who lack the finances or tech exposures needed for them to have online presence, but there has always been something related to scam about the company that prevented its basic business model taking root in strong business practices. My concerns about Groupon are as follows:

1. Poor risk management in running deals and weak internal controls: on what figures does Groupon center its refund reserves? Yes, the company keeps refund reserves but what is its size and how was that calculated? It was because of Groupon’s poor risk assessment and management that the company had to restate its fourth quarter earnings last March. In fact, Groupon has not been able to track the number of its outstanding Groupon values, which is why I think the company has weaknesses in its internal control. An analyst gave an estimate of the refund rates of Groupon to be in excess of about 40 percent year-over-year, which means the financials the company has been reporting over the years must have been laden with utmost intentional secrecy. I leave you to draw your conclusion on what you think is the true financial strength of Groupon!

2. Overly generous ‘’Groupon promise’’ which translates into higher refund rates: perhaps because the company wants to impress its customers with the certainty of refunds where necessary, it has been granting overly generous refund promises that if implemented will make nonsense out of its sales records. Of course, the financial reports of the company aren’t showing much of that. Its March quarter result says the company has enough cash and no debt, which looks good on paper, but I’m skeptical about it, not because I want Groupon to fold up, but because I strongly feel the company is being economical with the truth.

3. Deliberate maintaining of accounting records full of irregularities: it’s no longer news that Groupon has been keeping irregular accounting records that often require restatement after each quarter release. News of its recent return-loss provisions has sustained the downward trend of its stock price from $18 per share to about $7 presently.

4. Running medical deals that require special qualifications, but Groupon has no means to determine who is medically qualified and who is not before selling. Groupon runs medical deals that require specific qualification but the company isn’t able to determine who is qualified before making sales. The effect of this is that its refund rates will increase, creating greater risk for its cash flow on the long run if nothing is done to address the trend. Often, Groupon also runs deals such as in travel where important facts are kept away from customers, or it runs travel deals without requesting customers to pre-arrange their travel dates and confirm availability at the time of purchase. This is one of the important procedures that helps major travel providers like Expedia (NASDAQ: EXPE), Travelocity, Priceline (NASDAQ: PCLN) keep their customers. The effect of the failure of Groupon to include this procedure encourages consumers to ask for refunds if after some months they find that they can’t use the Groupon deal again.

I know that emotions and biases often play a role in investing but in my opinion, investors should always try to be curious and watchful in matters concerning investing in common stocks. Groupon and its tech competitor, Facebook (NASDAQ: FB) are two stocks with common fate. Investors must have lost close to $15 billion and $34 billion in Groupon and Facebook respectively after the initial public offerings of the two tech companies. I strongly believe that many investors were really unaware of the huge risks inherent in these companies when they bought the common stocks. I know that Groupon will be making its next financials public August 13 but I’m short on Groupon until the company reverses all its negatives – if it’s able to.

About the author:

Muhammad Bazil
Muhammad Bazil is a financial journalist and editor for a variety of websites, public policy organizations, and book publishers. He has written hundreds of published articles and blog posts on topics including budgeting, credit management, real estate and investing. His articles have been featured on the homepage of Yahoo!, MSN and numerous local news websites.

Rating: 3.2/5 (10 votes)

Comments

Dr. Paul Price
Dr. Paul Price premium member - 1 year ago
Published on RealMoneyPro.TheStreet.com April 18, 2012 witrh GPRN @ $12.58 /share...

Cash in your ‘Groupon’

Sometimes you don’t need an MBA or have to do fancy analysis to know that a business model is unworkable. Social Networking is hot but Groupon [GRPN], the company, is not. My wife likes to eat at Floga, a nice local, non-chain, Italian restaurant located near us. The food is good and the menu prices are moderate with typical entrees running about $13 – $24. It is a BYO operation.

Last week we got a Groupon offer for $25 of food for $12. There were no minimum purchase requirements and no restrictions about using it on weekends or holidays. Most vendors get only 50% of the amount GPRN collects. That put Floga in the unenviable position of having to provide $25 worth of food and drink for $6. That’s a money losing proposition unless the diners spend way more than $25.Worse still, there were over 600 of these certificates issued over a three-day period. We went last Friday night and saw almost every table with the telltale computer printed sheet designating them (kindly) as bargain hunters and, from the owner’s viewpoint… cheapskates.

Floga needed extra wait staff to serve the larger than normal crowd yet likely didn’t even break even on the night. If there were any full paying customers they might have been displaced by the Grouponers. A couple of weeks earlier my wife used a $25 Groupon to have a $60, stated-value, massage. The masseuse told her she couldn’t possibly schedule all the paid-for sessions without very negative cash flow. She called her Groupon sales rep who said, “Tell customers you can no longer honor the offer. If they complain to us, we [GRPN] will issue refunds.”

I read a similar horror story of a gourmet cupcake shop that actually provided 15,000 dozen at a loss while paying overtime wages and taking on huge upfront costs. The food was sold at a loss of $25,000 which represented the net profits from the previous full year’s earnings. The theory is that customers will try you out at discounted prices and then come back on normal terms. Most businesses are finding out that Grouponers’ mindset is to simply move on to the next bargain.

Competitors like Living Social are providing the same services as Groupon with generally identically dismal results for business owners. The re-up rate for GRPN’s services is justifiably bad. This is like a multi-level marketing firm like the old AMWAY in the sense that when everyone has already been approached the game is over.

GRPN shares touched a new post-IPO low intraday Tuesday at $12.25 before closing at $12.58. This was on a day when the DJIA was up 194 points and the NASDAQ composite gained 1.82%.

Groupon lost $0.08 per share in 2011 and is expected to lose money again in 2012. They’ve never turned a profit despite ramping up their revenues from $5 MM in 2008 to $1.61 billion last year. GRPN will not go bust in the short run because they are debt-free. That shouldn’t stop you from selling if you own it. My ultimate target is ‘liquidation value’ unless they come up with a viable business model. Option savvy traders could consider buying puts out to October 2012 or January 2013.

The Trade: SELL GRPN

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