Groupon discounts expectations for its IPO

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Groupon is finally ready to launch its IPO with a scaled-back offering that seeks to win over the daily discount deal company’s legion of critics.

After an IPO build-up marred by persistent criticism of the three-year-old company’s business model, accounting and leadership, the underwriting team of 14 banks remains confident that perceptions of the company can be changed when management actually gets a chance to tell the story on the roadshow due to formally start next week.

Groupon plans to sell 30m shares at a price range of US$16-$18 a share for a valuation of US11.4bn or less, well south of earlier estimates of more than US$20bn. At the upper end, the deal would raise US$540m in fresh capital, less than the US$750m amount nominated in its IPO registration document first filed with the Securities and Exchange Commission in June.

The company is being pitched on a valuation that is comparable with Amazon based on a 2012 revenue multiple, but a significant discount to Amazon’s 2013 multiple.

Morgan Stanley, Goldman Sachs and Credit Suisse are lead underwriters. The deal is expected to price on November 3 after a US-only roadshow.

“The focus really is to get in and out of the market as quickly as possible,” said one syndicate source of the decision to market exclusively in the United States. “It doesn’t make a lot of sense to go to Europe given the lack of participation in new issues.”

Management and the deal team will conduct teach-ins with major banks involved in the transaction on Monday before the roadshow travels to the Mid-Atlantic then Boston, New York (for two days), San Francisco, Denver, Los Angeles, the Midwest and Chicago.

A key disclosure in the updated filing is that each of the 2.4m Class B shares outstanding will have 150 votes, leaving Groupon tightly controlled by executive chairman Eric Lefkovsky, chief executive Andrew Mason and co-founder Bradley Keywell. No existing shareholders are selling into the offer, though this was part of the initial plan.

Groupon has copped criticism that the bulk of the US$1.11bn it has raised from venture capital, some US$942m has been used to cash out insiders, including Lefkovsky.

Operational Scrutiny

The latest S-1 also includes September quarter results, showing a 496% year-on-year improvement in gross billings to US$1.16bn and a 426% gain in reported revenue to US$430.2m. The company, which has 142.9m subscribers and now makes most of its revenue overseas, also made a US$239,000 loss from operations in the latest quarter, down from US$101m in the June quarter.

Groupon said the improvement it saw in operating performance in North America was the result of its ability to lower marketing expenses while still driving customer growth. International losses were higher because of additional investments in less mature markets in South Korea,?Australia?and Japan.

Bankers close to the deal noted that most issuers were choosing to defer in this market, despite the strong October rebound in US stocks.

“Most CEOs and boards are choosing to wait for things to stabilize unless they need to go now or they want to get the process over and done with,” one said.

Groupon critics believe the company falls into the former category, arguing that even though operating cash flow is positive, it relies heavily on short-term cash from slowly paying its merchants and needs more cash to fund its working capital.

Yet those close to the IPO say Groupon is simply eager to finalize its IPO and emerge from SEC quiet period restrictions that have limited its ability to defend itself against the critics (despite several valiant efforts by management to test the rules).

Groupon, which collects cash upfront from the sale of its discount coupons and pays merchants offering those discounts their revenue share at a later date, held US$243.9m in cash and cash equivalents at June 30 (up from $225m at June 30) but had an accrued merchant payable balance of US$465.6m.

“There has always been a discussion on whether they actually need the money,” noted one investment banker. “The debate is whether the merchants are actually floating the business.

“Look, there are a lot of companies that rely on subscriptions that generate operating losses but are cash-flow positive, and don’t receive the same level of scrutiny. My view is that they are generating cash.”

Max Wolff, senior research analyst at Greencrest Capital, said Groupon had become the “battleground” between believers and non-believers in private technology company valuations.

Greencrest, which specializes in coverage of private companies, values Groupon at US$7-$8bn, while Hudson says Groupon is worth US$8.7bn at a peer price/sales ratio of 2.5 times 2012 forecast revenues.

“We still believe that management’s decision to price the offering and start the roadshow will not do much to push back the voices saying they are running out of money,” said Wolff.

Still, he conceded Groupon’s September quarter numbers looked “much stronger than the many on the Street anticipated, due to reduced marketing spending.”

Hudson Square Research analyst Daniel Ernst said in a note to clients that the key question for Groupon was what level of marketing expenses was necessary to maintain revenue growth and ensure profitability.

Though Groupon’s gross billings growth has fallen in recent quarters (from more than 1,353% in the first quarter of 2011 to 860% in the second quarter of 2011) and revenue per customer has also fallen, marketing as a percentage of net revenues has also fallen, Mr Ernst noted.

A deal size of around US$500m would limit available free float and draw comparisons with the tightly orchestrated IPOs of LinkedIn and Zillow earlier this year. But bankers argue a US$500m offering would still be a sizeable deal by recent standards (LinkedIn and Zillow were smaller offerings) and Groupon could still add a secondary element to the sale if there is enough demand.

Much has also been made of the SEC scrutiny of the offering document.

Though Groupon has been forced to make some significant changes — including removing the “gross billings” measure to more than halve its reported top-line revenue — filings of SEC comment letters show most high-profile IPOs were forced by the SEC to add disclosures or change the wording of their prospectuses in one way or another during the review process.

There is no doubt that the SEC has been particularly sensitive about companies’ revenue recognition, their use of non-GAAP measures and assumptions used in determining the fair value of stock.

Few IPOs in recent memory have faced as much scrutiny as Groupon, which critics argue should have accepted a US$6bn buyout offer from rival Google last year.

“This company has been a lightening rod,” the second banker said. “The general view on this company has been negative ever since they turned down the offer from Google.”

Groupon?s beginning

Groupon began in 2008 when computer programmer Andrew Mason, a Northwestern University grad and former punk band keyboardist, figured out how to get people excited about the low-margin business of coupons.

Mason?s brainchild: sign up merchants to offer coupons online through a website and Groupon?s email subscriber list. Shoppers who see these ads on their computers, tablets or mobile phones can then buy the coupons, getting bargains on everything from knee socks to Botox. The deals are targeted toward customers? cities and preferences. Groups bidding on coupons equals ? voila ? Groupon.

Groupon is expected to go public Nov. 4. The company could not comment for this story due to the quiet period for its IPO, during which time company officials are barred by regulators from discussing anything about the firm. But interviews with analysts, investment managers and merchants tell the story of a company that grew too fast as it raced to go public.

Sources: Reuters, washingtonpost

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