Groupon's Accounting Issues Are Worse Than You Think

Investors shouldn't be too surprised that Groupon (Nasdaq: GRPN  ) is being forced to restate earnings for its first quarter as a publicly traded company. Like the proverb goes: Fool me once, shame on you; fool me twice, shame on me. This isn't the first time the daily-deals site has tried to convince shareholders that its problems are only skin deep.

Does Groupon's latest accounting mishap foreshadow its eventual demise? Not everyone thinks so. Some say the company is just working out the kinks of its novel business model. Let's dig into the details and see what's really in store for the Chicago-based company.

The price is not right
After the market closed Friday, Groupon said a so-called "material weakness" in its internal systems was at fault for the inflation of its fourth-quarter revenue by $14.3 million. Turns out it also slid some operating costs under the rug, which will now (once properly accounted for) reduce Groupon's fourth-quarter operating income by $30 million. As for other key financials, net income will suffer a $22.6 million loss, and earnings per share will drop $0.04 from what the company had previously reported.

The "my bad, it won't happen again" line isn't going to work this time. Investors who had given Groupon the benefit of the doubt before have no doubt learned their lesson. Shares plummeted 6% on the news in after-hours trading. But that's nothing compared with the 30% decline they've seen since the stock's IPO last November.

That brings us to the first warning sign Groupon gave investors before going public.

Pre-IPO investigations 
In 2011, the deal-of-the-day website misleadingly disclosed the total number of customers having ever bought a Groupon offer in a portion of the S-1 clearly reserved for quarterly results. There's no excuse for that. Information presented in this form should be clearly defined. The fact that Groupon went out of its way to make the S-1 reports extra confusing was the first red flag for investors, as I wrote in January.

So where does the Internet startup go from here?

As far as loyal followers go, there's no shortage of rival deals to be had from other big names, including LivingSocial, which got significant backing last year from Amazon (Nasdaq: AMZN  ) , which invested $175 million in the rival deals site. Meanwhile, Groupon walked away from a possible merger with Google (Nasdaq: GOOG  ) for a rumored $5.3 billion. Google went on to create its own deals service called Google Offers, which emails members daily deals from local businesses and restaurants. As my Foolish colleague Sean Williams noted, even Microsoft (Nasdaq: MSFT  ) is playing in the deal space. The software company launched a service last year that it dubbed MSN Offers, which brings users the most popular local deals from Groupon, LivingSocial, and Google.

What's the deal, Groupon? 
Clearly, it's not difficult for others to enter the daily-deals space. And with Groupon once again showing weakness in its core operations, the limited barrier to entry only worsens the situation for the newly public company. Groupon's business model relies heavily on its ability to manage receivables. For this reason, more customers demanding refunds than the company expected signals a fundamental problem with the way Groupon runs the business.  

An analyst with Venture Beat suggests that Groupon's shift toward bigger deals is partially to blame. That's because the offers often come with restrictions that the company doesn't account for when it sells the deal to a customer. For example, Rocky Agrawal references a Groupon for a treatment called cool sculpting, in which he explains:

In order to get the treatment, patients must be medically qualified. But Groupon has no way of medically qualifying purchasers and will sell it to anyone. When they go to the doctor and find out that they aren't eligible, they call Groupon for a refund.

By operating like this, the company is telling shareholders that it's only concerned with immediate results and has no long-term strategy in place. You see, selling higher-priced deals means more cash up front, therefore boosting Groupon's revenue -- but only until those customers demand a refund, at which point Groupon's already short the portion of sale it paid back to the merchant. The outcome? Groupon suffers more refund losses.

More than mere growing pains
Groupon's inability to manage refund risks tells me that its latest accounting oversight is more serious than even the company would like to admit. Without a long-term strategy, Groupon will continue to back itself into a corner and lose investor confidence. As a consumer, I'm not one to turn down a good deal. However, as an investor, I'd be shortsighted not to give Groupon a thumbs-down rating on my profile in Motley Fool CAPS.   

While it was a relatively small amount of total deals that were recently restated, I'm not confident in Groupon's ability to run a profitable business. Groupon's infrastructure may not be ready to support future growth, but The Motley Fool's leading analysts have uncovered an even better stock for your portfolio. To discover The Only Stock You Need to Profit From The New Technology Revolution, get your free copy of the report now.  

Fool contributor Tamara Rutter owns no shares of any companies mentioned in this column. Follow her on Twitter, where she uses the handle @TamaraRutter, for more Foolish news and investing ideas. The Motley Fool owns shares of Microsoft, Amazon.com, and Google. Motley Fool newsletter services have recommended buying shares of Google, Microsoft, and Amazon.com and creating a bull call spread position in Microsoft. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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