I Don’t Need the SEC to Tell Me to Avoid Groupon Stock

For some time now, I’ve felt almost like the proverbial lone voice in the wilderness questioning the value of Groupon as an investment.

My primary issue with Groupon is that there is nothing inherently unique about its business model. Given that fact, I don’t understand how a company that really has no way of fighting off competitors can be valued at between US$10 and $15 billion, which are the numbers investment bankers have attached to Groupon at various times over the past year.

Now it seems the SEC — after reading the paperwork Groupon filed in support of its highly anticipated initial public offering — also has some questions about this high-flying company’s business model.

This is good news for potential investors, particularly those who lack the connections to be first in line to snap up shares of newly public companies. Those investors, often referred to as “the little guys,” tend to take losses on stocks that start out hot and then cool off after the big guys — those at the head of the line — have sold them for a profit.

The SEC might prevent that from happening in this case by simply taking a closer look at Groupon’s IPO registration statement. Giving Groupon additional scrutiny also might send a message to all the other social media companies that are expected to launch IPOs in the near future.

Here’s the message: Make it as easy as possible for potential investors to determine whether your operation actually has a chance of becoming a sustainable, profit-making enterprise.

Unconventional Measurements

Again, I have my doubts about Groupon’s ability to turn a profit, especially over the long term, largely because it does not have a unique business model. Not surprisingly, Groupon Founder and CEO Andrew Mason sees things differently, and he says as much in the introduction to the company’s IPO registration statement.

“We don’t measure ourselves in conventional ways,” Mason wrote before going on to explain why Groupon’s statement contains some unconventional metrics to gauge the company’s financial viability.

After hearing the SEC’s initial reaction to some of those metrics, Groupon amended its original registration statement. Still, it seems like the process of reviewing its IPO application, which normally takes about 30 days, may carry into September. The original application was filed in June.

The SEC is reviewing two specific Groupon metrics: gross profit and something called “consolidated segment operating income.”

“Gross profit” is defined as total sales minus costs of goods sold. For Groupon, that’s probably a tidy number, if you can buy the estimates of its annual revenues, which have ranged from just over $500 million to more than $2 billion. If sales are anywhere in that range, gross profit should be substantial, considering Groupon doesn’t actually manufacture any goods. It sends coupons via email that its customers print before using.

What Is CSOI?

The only problem with using gross profit to bolster the case for buying Groupon stock is shareholders get paid from net profit, which isn’t realized until after all operating expenses are deducted.

The need to account for all expenses is why the SEC wants further explanation of exactly how Groupon defines “consolidated segment operating income,” or CSOI.

As far as I can tell, Groupon defines CSOI as operating income, minus a range of expenses. It’s not clear what all those expenses are, but marketing costs — which for Groupon is a huge expenditure — are not on that list.

In fact, by excluding marketing costs from its income calculations, Groupon turned a $98 million loss into an $86 million profit in the first quarter of this year.

No wonder the SEC wants to take a closer looks at Groupon’s financials. When taking that look, it will find that Groupon’s marketing expenses are huge — amounting to 94 percent of its gross profit in 2010.

Groupon’s approach to compiling financial metrics is bringing up memories of the dot-com days, when companies wowed Wall Street by counting how many “eyeballs” they were drawing to their websites.

I suspect technology entrepreneurs will never stop trying to convince the rest of us that we shouldn’t try to measure their ventures by traditional business metrics.

There may be some validity to that line of thought, but in the current economic climate — on the heels of a major housing and credit market meltdown and with the memories of the dot-com bust still lingering — it would be a good idea for companies to at least measure themselves in ways that make sense.

Measures That Make Sense

It also would be a good idea for investors to look for real, reliable metrics — not funny numbers made up by hot shot techno geeks.

There are ways to measure the value that daily deal sites like Groupon bring to businesses that offer their deals to consumers.

For instance, MobManager is an application that lets merchants track redemptions and the average amount of each sale associated with daily deal offerings from several companies, including Groupon and LivingSocial. The app also provides a means of collecting email addresses to send follow-up offers that don’t include the daily deal site.

Several MobManager users have said they can prove they are making money on their association with Groupon. And MobManager’s own data shows that roughly 7 percent of Groupon users who provide the merchant an email address come back to make another purchase within two to three weeks of redeeming a Groupon.

That’s a fact that Groupon should try to convert into a metric to convince both the SEC — and potential investors — that it is a viable business.

Still, there’s one number that sticks with me whenever I think of Groupon: the number of competitors that enter its market every day.

Just watching this makes me think the daily deal concept is here to stay. Revenue in that space is expected to grow from $870 million this year to more than $3.9 billion by 2015, according to BIA/Kelsey.

Still, I don’t see how one company can dominate a sector with such a low barrier to entry. That’s why I don’t need the SEC to tell me that Groupon stock is one deal I should avoid.