Groupon (GRPN) appears to be asking would-be IPO investors to accept an accounting trick in order to believe that is is profitable. In his introductory note to the company's public-offering filing, founder Andrew Mason writes, "Life is too short to be a boring company." Judging by the numbers he presents, he's already delivering on that promise.
The email coupon company's top-line financials are impressive: in Q1 2011 it saw $644.7 million in revenues from 83.1 million users.
It is the company's bottom line that's the problem: Despite almost equaling the entire revenue of 2010 in just the first quarter of this year, Groupon still showed a net loss of $114 million.
Mason, however, wants investors to concentrate on something he calls "Adjusted Consolidated Segment Operating Income." On that measure, Groupon saw income of $82 million in Q1.
But this is a fiction, as the company admits, because it generates that "income" by ignoring some of the major costs of Groupon's business, particularly its gargantuan marketing budget.
Pay no attention to the marketers behind the curtain
The reason Groupon is so far from making money despite running what is clearly a massive and growing business is because Groupon is paying dearly for that growth.
In Q1, it spent $208 million on marketing, of which $179.9 million went for online marketing to acquire users from social networking sites and search engines.
Another $179 million went largely to grow Groupon's sales force.
Yet Mason wants you to pay no attention to all those marketers behind the curtain. The IPO offering asks instead that you concentrate on "Adjusted CSOI":
This metric is our consolidated segment operating income before our new subscriber acquisition costs and certain non-cash charges; we think of it as our operating profitability before marketing costs incurred for long-term growth.In addition to not counting marketing, "Adjusted CSOI" excludes interest, taxes, or non-income cashflows like changes in accounts payable.
In other words, Groupon is "profitable" as long as you ignore all the expenses it must make to keep going.
By amazing coincidence, if you do ignore all that, then Groupon's business is improving dramatically:
Ignoring the marketing costs is a real act of chutzpah at this stage of Groupon's short history. The company itself says:
Online marketing expense primarily represents the cost to acquire new subscribers and is dictated by the amount of growth we wish to pursue.A more accurate look at profitability trends at Groupon is can be found in this breakdown of Groupon's expenses as percentages of its total revenue:
Clearly, operating expenses -- mostly marketing and sales -- are rendering Groupon increasingly unprofitable, regardless of what its "Adjusted CSOI" says.
At only 83 million users, Groupon has plenty of room to keep growing.
(Facebook is at 600 million.) As it gets there, Groupon's mix of users is becoming increasingly non-American.
Foreign revenues increased from 37.2 percent to 53.8 percent of the entire business in Q1. That suggests that U.S.
growth may level off sooner than foreign growth. Nothing wrong with that, but it means Groupon will keep needing to churn that massive marketing/user acquisition budget to get there, crushing its profits.
Groupon admits this, too:
We cannot assure you that the revenue or gross profit from subscribers we acquire will ultimately exceed the cost of acquiring new subscribers.Groupon can't track its users
And finally, Groupon also appears to have a "LinkedIn problem" -- i.e. many of its "users" don't actually use the service:
Our total number of subscribers may be higher than the number of our actual subscribers because some subscribers have multiple registrations, other subscribers have died or become incapacitated and others may have registered under fictitious names.Presumably, Groupon is hoping that once a person registers, she becomes a stable, permanent user of the service, and the company need not spend any further cost reacquiring her as a user.
What to watch for in Groupon's IPO
Given the challenges inherent in identifying these subscribers, we do not have a reliable system to accurately identify the number of actual subscribers, and thus we rely on the number of total subscribers as our measure of the size of our subscriber base.
That may be, but as every other subscription-based business has found, acquiring and retaining users tends to be a permanent state of affairs, not a temporary startup obstacle.
Related:Image by Flickr user photoclinique, CC.