Analyst: Groupon Now Risks ‘Self-Reinforcing Path to Insolvency’

Groupon’s troubles are bad — and they’re likely to get worse, says Sam Hamadeh, founder of the New York-based financial analysis firm PrivCo.

Since Groupon released its third and most recent amended S-1 document — excluding what it pays out to merchants, and revising its reported 2010 revenue of $713 million down to $313 million as a result – PrivCo employees have been poring over the filing, looking for other clues about Groupon’s business.  Now, Hamadeh says Groupon’s breathtaking adjustment may be a prelude to an enduring insolvency situation. The reason? News out of Groupon has been so bad for so long that a growing number of Groupon’s merchant customers is now worrying they’ll never get paid, he says.

I talked with Hamadeh yesterday, asking him to explain how PrivCo arrived at its conclusions. Our conversation has been edited for length.

Groupon’s revenue restatement was massive. What does it mean?

It means that Groupon is technically insolvent. As of June 30, Groupon had just $225 million in the bank and it owed merchants $391 million for their share of Groupons sold. It’s living off float from merchants. That’s Groupon’s short-term financing.

And merchants are starting to see it as cash-strapped.

I was interviewed by the Chicago Tribune yesterday and CBS radio and what I heard — including from people who called into the radio show —  is that local merchants in Chicago are panicking. There are restaurants in Chicago that are now wondering if they’ll get paid in two to three months, and the only way for Groupon to stay in business is to convince merchants that they’ll [see their end].

Consumers are nervous, too. If you’re someone who might pre-pay for a meal or a massage that you might use four months from now, you have to be wondering if Groupon will still be around.

Are you suggesting we might see the equivalent of a run on a bank?

It’s not immune from a run. It’s [on a] self-reinforcing path to insolvency. Consumers pre-pay and merchants delay their receipt [of their part of the sale]; that’s the whole model. But once there is a question on either side about whether you are getting paid or not – once merchants stop honoring Groupons because Groupon isn’t paying them or they’re afraid Groupon won’t pay them, [Groupon enters into] a death spiral. And the way physics works, once you start to go down, there’s no way to lift up.

It isn’t a direct analogy, because Google Offers is only in about a dozen major cities [versus Groupon, which is in hundreds of cities in dozens of countries], but Google offers four-day turnaround for payment after the close of a sale, and that’s not insignificant. If you know anyone running a small business, you know that they kind of live month to month.

In addition to potentially freaked out vendors and competitors, you note in a newly issued research report that another big danger for Groupon is that its coupons might come to be viewed as pre-paid gift certificates. Why is that important?

Groupons typically expire after a few months, but if Groupons are deemed as gift certificates, it would be illegal for them to expire in less than five years, depending on the state. That could be bad news for Groupon because right now, approximately 20 percent of Groupons go unused [by their stated expiration], and that cash gets pocketed by Groupon and its merchant partners.

Groupon [in its newest S-1] said that as of June 30, it had $680 million in short-term liabilities. But given PrivCo’s estimates that the total, cumulative Groupons sold through August total more than $2.5 billion, the company potentially has another $500 million liability from the fact that they’ve kept half [the money] from [unused] U.S. coupons, and 100 percent of the Groupons from unused deals abroad. [Unlike in the U.S., if the Groupon deal of a merchant abroad isn't used, Groupon keeps the entire amount.]

There’s also the notion of unclaimed property. If after five years, for example, a consumer fails to use a gift certificate for Bed, Bath & Beyond, that money typically goes to the state government where the consumer lives. Right or wrong, that’s the law. So if you sell a gift certificate and it’s not used, it becomes unclaimed property. If no one claims it, the government keeps it. So it’s possible that Groupons will come to be deemed as gift certificates and [when not used] as unclaimed property, and that’s a potential liability that no one is talking about.

How likely is that scenario?

There are numerous class action lawsuits that center on the way that Groupon’s discounts are sold and that argue that Groupons are really pre-paid gift certificates.

It’s already now the case that if expiration dates aren’t lawful in your jurisdiction, Groupon will include in small print that its expiration date isn’t lawful, and that the merchant has to honor your Groupon, and if they don’t, Groupon will stand behind it. But do you really want to show up for dinner with your date and be arguing with the merchant about expiration dates?

Do you think Groupon can still have its IPO?

Could they go public if they slash the price low enough? Yeah. They have to do something fast. Because of the nature of Groupon’s business, any smell of credit risk [can be fatal].

Public market investors aren’t that sophisticated. It’s hard for even sophisticated business reporters to read through a 150-page S-1 [like that of Groupon]. But I think instead of an IPO, it’s more likely that everyone who has invested in Groupon will have to cough up more money. The ironic thing is that Groupon would already have it if [its management] hadn’t diverted about $940 million of the $1.12 billion the company has raised in private funding to cash out founders, investors, and other insiders. How the board made those determinations, I don’t get it.

I saw that [Groupon chairman and co-founder] Eric Lefkofsky led a group of investors in buying the historic Wrigley building in Chicago for around $40 million last week. It’s really strange. It’s almost as if they were saying, “We took our money out. We knew every metric was declining. But we’re successful businesspeople, see?”

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11 Comments

  • This is stunning stuff: I’m surprised it hasn’t caught fire and been discussed more broadly. You can’t spin FACTS. A lot of people have wondered about the long-term viability of Groupon’s business model (what with inevitable margin compression, etc), but running a company based on float from Mom-&-Pops is about the worst business idea possible.

    NEA and the other investors who got the heck out look like geniuses but what in God’s name were the people who bought into the last round thinking about seeing their investment $$$ all go out the door?

    Wow.

  • > How the board made those determinations, I don’t get it.

    Actually, the bigger question is: which minimum security prison the board would like to attend in the near term future? This sounds a lot like the private equity equivalent of “Enron” – they knew the revenue model wasn’t valid, yet…

  • yet…they convinced a dozen or so sophisticated venture capital firms to shower them with money. i don’t get it, but i also don’t think anyone is going to prison here considering the players.

  • > i also don’t think anyone is going to prison here considering the players

    I’m sure that’s what Ken Lay (RIP) thought…

  • I’m no Groupon fan, but Hamadeh’s statements are pretty ridiculous. While the scenarios he outlines are technically possible, they are simply not going to happen barring some kind of cataclysmic external event that causes all of Groupon’s big backers to stop funding anything. While Groupon has clearly lacked conservative financial principles, there is still a lot of value there. If they can’t go public and they somehow were caught in a cash crunch (which is not all that likely), their investors would clearly pony up some money rather than see their investment evaporate. And Groupon would clearly take the money if they had to. They could even do that in concert with changing their merchant payment terms if that became a big issue. That would affect their cash cycle and their valuation but nothing more. And the “massive revenue restatement” has zero effect on whether the company is solvent or not – it’s 100% cosmetic. It’s really a reclassification rather than a restatement. So yes, Groupon has issues. Yes, the early investors/founders seriously undermined the company by enriching themselves to such great lengths so early on. And yes, they are probably worth only a fraction of what they thought they were. But no, Groupon is not going out of business, not matter how pleased that would make some people.

  • The investment thesis for VCs is the bigger fool theory. They thought they could flip this scam on the dummies in the public markets.

    More amusing is that Google considered buying this mess for $6b despite the obvious business model issues that anyone with the most basic financial analysis skills should be able to see. Smartest guys in the room? Ha.

  • I ran an ad several months ago and still have not received all my payment. Everytime I contact my rep, they give me a new date.

  • PrivCo and Sam Hamadeh’s analysis is spot on. How could the founders and early investors demand to be cashed out for over $940 million when this company’s obviously needs the money, given they owe more to merchants alone in the short term than they had in the bank. A board has an obligation to protect the company’s creditors as well.

    And it’s not as if these founders and VC had been waiting patiently for a decade for some liquidity. The companies barely 2 years old and these “early VCs” had invested only months before the cash out! There’s virtually no precendent for this!

    Bravo to PrivCo.com for a such an intelligently thought out analysis – (and for PEHub and Connie to taking the time and space to layout some valuable objective analysis.) More of this please!

  • If I were an equity analyst and had read news reports that the Groupon IPO was still moving forward but wanted to make some money what would I do? I guess I’d issue a remarkably negative report on the stock when no one else — not the company nor its bankers — is legally allowed to respond completely trashing the stock and claiming bankruptcy is imminent. Then I go pitch it to every media outlet that would listen. Since the secondary markets are so illiquid this should drive down the price. And I would know this since the only reason to issue an analyst report on a private stock is if the secondary market participants were my target audience. Hopefully I could get some some scared low level employees to sell me their stock really cheap. But I’m not an equity analyst, so I wouldn’t do that. I wonder if there’s anyone out there that might…

  • Dan

    Why would the VC put in good money after bad? Do you think the founders will put back in the 900 mm or so they skimmed out of the last rounds?

    I htink it is safer to assume that they will have to do with the current working capital – and not count on the IPO to shore up liquidity

  • WWSD: A high-school freshman could recognize your post for what it is: an Ad Hominem attack. You offer NOTHING that responds to the analysis. You note that you’re not an analyst. Fair enough. But the analysis that was done here is not advanced: it is the MOST BASIC of all financial statement analyses.

    When a company has more payables than cash, that equals trouble: especially when their payables are going to Mom-&-Pops, to whom you can’t just say: “hey, stop giving us grief, we’ll get you your cash when we get it to you.”

    I have no horse in this race, but the facts that are emerging are remarkable. I hope they get public, ’cause I’ll make a boat-load of dough shorting the stock.

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