3 Reasons to Steer Clear of Groupon


We may now be just weeks away from Groupon's long-awaited IPO. As long as the market plays nice -- a dicey proposition these days -- the rapidly growing leader of the red-hot flash sale market should be able to make its Wall Street debut in the next month or two. Groupon updated its filing with the SEC this morning, cleaning up a controversial accounting metric while also publishing its latest quarterly results.

I noted three unwelcome surprises in Groupon's original prospectus two months ago. They aren't any less problematic today, so let's refresh those concerns.

1. Groupon is losing a lot of money
The key to driving Groupon toward its likely 11-figure valuation is the model. Selling prepaid vouchers for city-specific experiences at a huge discount -- and pocketing roughly half of the proceeds -- should be generating ridiculous profitability.

The allure of big margins has attracted niche-specific leaders XO Group (NYS: XOXO) , Travelzoo (NAS: TZOO) , and OpenTable (NAS: OPEN) into breaking in similar offerings last year. If there wasn't some tasty gravy on the bottom line, Amazon.com (NAS: AMZN) wouldn't make meaty investments in LivingSocial, and Google (NAS: GOOG) wouldn't expand its already lucrative paid-search business by rolling out Google Offers.

Well, it's not really working out for Groupon that way. Despite selling more than $1.5 billion worth of vouchers through the first six months of this year, Groupon is reporting an operating loss of $219.7 million during the period. Expanding into new territories and aggressively marketing its offerings over countless copycats doesn't come cheap, but when will Groupon be profitable?

2. Groupon isn't as greedy as you might think
Groupon approaches restaurants, spas, and other lead-hungry local establishments with a tantalizing proposition. If they can discount an experience by roughly half -- and are willing to give Groupon half of that -- a company willing to take $0.25 on the dollar can receive a dramatic influx of new customers.

This isn't a perfect science. Groupon will try to get a larger chunk out of low-priced deals, and it's apparently willing to negotiate better terms for the merchant under certain circumstances.

So how much is Groupon actually paying its providers? We don't have to guess. "'Cost of revenue'" primarily consists of the amounts paid to and accrued for our merchants associated with the sale of Groupons," reads this morning's S-1 filing.

It was a good sign in the original prospectus when Groupon went from keeping just 39.2% of its top-line revenue in 2010 to 41.8% during the first three months of 2011. However, Groupon's gross profit in its latest quarter slipped to 38.8%. Comparing the first six months of last year with this year finds gross profit slipping from 41.3% to 40.1%.

This may still be a hot model, but it seems as if increased competition is forcing Groupon into making more merchant-friendly deals.

3. Groupon engagement isn't so great
Folks love signing up to access Groupon's daily deals. Subscribers have exploded to 115.7 million from 10.4 million just a year ago. But if you want to win an easy bar bet with friends, ask them to guess how many of Groupon's 115.7 million subscribers have actually bought a Groupon. The answer -- believe it or not -- is a mere 23.1 million cumulative customers.

Don't get me wrong. Who wouldn't love 23.1 million customers wielding credit cards? However, it's pretty startling that less than 20% of Groupon's registered users have taken advantage of a deal.

There's another problem evident in the latest update: Folks aren't spending as much as they used to. The average revenue per subscriber has fallen from $21 during the first half of last year to just $18 during the first half of this year. Is Groupon's mainstream push attracting more casual users than before? Is the plethora of deal sites that continue to pop up eating into its business? Is Groupon fatigue setting in?

Knowing all of this, I would still buy into Groupon at the right price. Unfortunately, that's unlikely to happen. If LinkedIn (NYS: LNKD) popped at the open, the faster-growing -- and, let's face it, hotter Web 2.0 play -- Groupon is going to be another big winner.

However, like the many Groupon offers that are starting to expire unused, I see a big case of buyer's remorse kicking in shortly after the IPO.

Will you be a buyer or seller of Groupon after it goes public? Share your thoughts in the comments box below.

At the time thisarticle was published The Motley Fool owns shares of Google. Motley Fool newsletter services have recommended buying shares of OpenTable, Travelzoo, Amazon.com, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.Longtime Fool contributor Rick Munarriz routinely checks the deal sites. He owns no shares in any of the stocks in this story and is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.The Fool has a disclosure policy.

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