Special thanks to Ron Adams,CPA, CVA, ABV, CFF & Mark Shifrin, ASA for providing a valuation analysis of Groupon in support of this post. Ron and Mark run the Valuation Services group of mid market investment bank Capstone Partners. The Valuation Services group provides valuation services in support of tax, legal and equity events.
Late last week, Groupon filed for an IPO that will value the company well above the $6 billion that Google reportedly offered last November. It could value the company as high as $20 billion if the estimates are accurate.
So should you buy Groupon on the IPO? With revenues estimated to reach $2.6 billion this year following revenues of $713 in 2010 and just $30 million in 2009, the company’s growth has been nothing short of miraculous – exceeding even that of Google. As a point of comparison, Google was valued at $34 billion at the close of its first day of trading, If you had bought its stock then (assuming you were not an insider and did not get the IPO price) your investment would have grown by 393% – a pretty good return by any measure.
BUT, companies like TIVO, MySpace and Netscape offer cautionary tales: Not every high flying tech company makes it. Some come crashing down almost as quickly as they rise. TIVO went public in late 1999 with a market cap of $4.4 billion. Today, the company, still public, is worth about 1/4 of that amount. MySpace was acquired in 2005 for $770 million – and at the time, people thought they had given the company away. Today, the decision to sell looks a lot better. And Netscape, whose IPO in 1995 was a cultural phenomenon, was dismembered by AOL and Sun Microsystems just 3 years later.
To help decide whether you should buy Groupon, we turned to Ron Adams, CPA, CVA, ABV, CFF and Mark Shifrin, ASA, who lead the valuation practice at Capstone Partners, LLC, a boutique investment bank, to add perspective on what a $20 billion valuation means.
"If you put aside the extreme valuations that come from excessive exuberance, the best way to value a stock is to value its future cash flows,” says Ron. “To get to a valuation of $20 billion, you’d need to believe that there is a good chance Groupon can reach revenues of over $50 billion by 2018 and have an EBIT (earnings before interest and taxes) of 20%. For a business where at least half the revenue goes right out the door to merchants, 20% seems like the upper limit of what Groupon could achieve. For comparison, Apple had revenues of $65 billion and an EBIT of 28% in 2010; Amazon.com $34 billion and 4.1%; and Google $29 billion and 35%.” (click here to download a PDF of Capstone’s Groupon valuation model)
So, will Groupon be the next Google? Or will it follow in the footsteps of TIVO, MySpace, and Netscape? To some extent, the issues that led to the undoing of TIVO, Netscape and MySpace are all present in Groupon.
Netscape: Netscape’s undoing was that it rose so quickly it could not consolidate its lead before competition jumped in. While the company was still solidifying its market position, Microsoft turned its complete attention to killing the company (a reaction that Netscape accelerated by stating that it wanted to replace Microsoft as the operating system). If it had more time to fly under the radar before incurring Microsoft’s full wrath, it’s possible Netscape could still be a major player today. Like Netscape, Groupon has exploded so quickly that it has triggered an enormous competitive response. In the case of Groupon, there isn’t just one competitor responding, but hundreds including goliath’s like Google and Facebook. A recent NPR story on Groupon said “Businesses report getting calls every day from another Groupon clone wanting to do a deal”
TIVO: Despite all of its ingenuity, TIVO was ultimately a Sustaining Innovation – not a Disruptive Innovation. Sustaining Innovations are ones that wind up as features of existing offerings. Disruptive Innovations are ones that enable start ups to beat incumbents despite their scale and market position advantages. They are usually based on a hard-to-duplicate technology breakthrough (like Google or Salesforce.com) or on the network effect, where more users result in more value (like Facebook or LinkedIn). In the case of TIVO, the cable companies were able take over the market by duplicating DVR functionality and integrating it into their set top boxes, making it a more appealing choice than buying a stand-alone TIVO. Like TIVO, Groupon doesn’t have an obviously disruptive technology and is at risk of being overtaken by other online giants.
MySpace: MySpace’s rapid ascent masked a fundamental problem with its business. As Facebook has shown, what most people want from social networking is a way of bringing their offline life online, not participating in an online singles bar. After the initial fascination, people tired of MySpace and the company faltered. In Groupon’s case, consumers may never get tired of getting deep discounts, but there are already signs that merchants may be getting tired of giving them.
A big part of the Groupon’s success has been its ability to offer discounts of 50% or more. However, recent deals, while technically offering a deep discount, are eroding the Effective Discount by only covering part of the purchase. Several months ago, we bought a restaurant Groupon offering $50 worth of food for $20. A recent Groupon for a similar quality restaurant offered $20 worth of food for $10. While the second Groupon appears to offer a 50% discount, because the average meal for 2 at the restaurant is about $50, the Effective Discount is only 20%. (The average spent for the meal is $40 – $10 for the Groupon plus $30 to make up the difference between the value of the Groupon and the price of the meal. With a total cost of $40 for $50 worth of food, the Effective Discount is only 20%). If Groupon cannot find enough merchants willing to provide the deep Effective Discounts that has driven its success, it will have a fundamental problem on its hands.
So, going back to the original question: Should you buy Groupon on the IPO? As Capstone’s analysis shows, the company will need to be unbelievably successful to provide any kind of return on a $20 billion valuation. While it is too early to count Groupon out, this is one IPO we’ll be passing on.