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3 Reasons to Steer Clear of Groupon 

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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 (NYSE: XOXO  ) , Travelzoo (Nasdaq: TZOO  ) , and OpenTable (Nasdaq: OPEN  ) into breaking in similar offerings last year. If there wasn't some tasty gravy on the bottom line, (Nasdaq: AMZN  ) wouldn't make meaty investments in LivingSocial, and Google (Nasdaq: 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 (NYSE: 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.

The Motley Fool owns shares of Google. Motley Fool newsletter services have recommended buying shares of OpenTable, Travelzoo,, 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 the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (5)

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  • Report this Comment On August 11, 2011, at 12:03 AM, liberty1955 wrote:

    I'm in the direct mail coupon business. Worked for ValPak since 1987 and now own my own marriage mailer business.

    While at first glance, Groupon looks like it's a good thing, buyer's remorse indeed.

    Not from stock purchasers, at least for now, but from merchants giving away offers for 25 cents on the dollar after Groupon gets their fee.

    Most dinner coupons only need to be a half off dinner offer.."buy one dinner at regular price and get the second at half price" with the disclaimer .."of equal or lesser value".

    Buy one get one free offers have a huge food cost in the second dinner. Getting a new customer shouldn't have to be this expensive.

    Groupon would be better off selling the ad to merchants for a 3 month time for a set fee and offering the half off dinner rather than taking a percentage of each Groupon sold..

    offer franchises to local distributors to cut costs for growth and have graphic artists designing the offers that appear on line.

    Merchants may get on board at first, but will soon realize the cost if that new customer doesn't come back again and AGAIN..WITHOUT THE HUGE DISCOUNT AS AN INCENTIVE.

  • Report this Comment On August 11, 2011, at 2:29 PM, chadhenage13 wrote:

    While I agree there are some pros and cons to Groupon's business model I will make a point that may be playing out all over. Groupon is popular enough that I registered for it and I get their daily deals. The problem is Groupon though they are making a lot of offers available in and around Baltimore, MD I live about 30 minutes north of Baltimore and while some of the deals are appealing they aren't exactly in my backyard. This could be part of why there are only 1/5 of users actually making a purchase. If Groupon can get it's deals closer to more of it's consumers this buy percentage is sure to pick up. This is part of the blessing and curse of being popular but not local enough yet.

  • Report this Comment On August 16, 2011, at 2:15 AM, phoebe44 wrote:

    During the first six or nine months that I was a registered Groupon customer, I purchased Groupon probably once every two weeks. The offers were great meaning they appealed to me and were things I needed as well as wanted.

    For the past six months, I've not purchased a single Groupon because the quality of merchants offering deals and the types of deals has changed to the point I am no longer interested. I used to be excited to check my email to see what Groupon had to offer that day - no more -- same old, same old now.

    Merchants are also providing selective, inferior service for Groupon holders. I've waited weeks for appointments after identifying myself as holding a Groupon only to find friends "get right in" when they aren't. Although the offer says it includes choices of products, once in the store as a Groupon holder, we find that's not true, really.

    I know Groupon stands behind their offers and refunds money in these situations (only as credit to be used for future Groupon purchases) but the disappointment in Groupon first and then the merchant has already happened to the Groupon customer - how many times am I going to understanding about a failed Groupon offer???

    Merchants aren't doing their part - they should be bending over backwards to assure Groupon customers are treated like first class customers - only then will we come back which is the goal - Groupon will get them in the door - but it is up to the merchant if we come back or not.

    I don't see a long life for Groupon unless they turn around the attitude of their merchants. They need to concentrate on the merchants as well as on the people who purchase the Groupons. Then, Groupon will have a viable business - one that I would want to have stock in. What Groupon doesn't see to know is it's not enough to have customers - the merchants need to do their part and right now it seems like the merchants really don't like - or outright resent - Groupon and their customers.

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