Thursday Grok: Nobody tell the Muppets that Groupon is a crock
- 05 April, 2012 08:15
Groupon is a crock. Its business model is deeply flawed and the numbers spat out by its accounting department are so rubbery you could bounce cheques off them. For the third time in less than two years, and barely six months after its IPO, the company has been forced, again, to acknowledge some shabby accounting practices.
To add to Groupon's woes, the Wall Street Journal reported that the Securities and Exchange Commission is examining the company's latest financial misstep and considering whether to launch a formal investigation.
The latest problems came to light on Friday when it restated its fourth quarter losses downwards from $42.7 million to $64.9 million after acknowledging it failed to accrue enough money in the accounts for refunds, while at the same time acknowledging a "material weakness" in its financial controls.
And for good measure, shortly after the earnings re-statement, Groupon announced it had agreed to settle litigation brought against it in 17 separate law suits which claimed the company “violated laws such as the federal Credit Card Accountability Responsibility and Disclosure ACT which prohibits the sale of gift cards that expire in fewer than five years,” according to the Chicago Tribune.
And this might just be the start of its legal problems. Bloomberg reported yesterday that the company is now being sued for securities law violations with hints of a class action in the ether.
That's quite a week, by anyone's standards.
And remember this is a company that in 2010 was forced to change the way it reported operating earnings after it was pinged for not including marketing expenses — its biggest cost — in its calculation, and which was subsequently pinged again for including money that was rightfully its business partners, in its own accounts. As Business Week noted yesterday, after scrutiny by federal regulators at the time, the company reduced its reported revenue by half. Yes, that right, by half!
This latest snafu came about as a result of much higher than anticipated refunds on its upscale Groupon Reserve program earlier this year. Basically, the company did not accrue enough the cover refunds. This may not seem like such a big deal, except that it got its accruals so wrong that the result was worse than the worst case scenario in its modelling, according to the WSJ.
So, it is losing money faster than it was letting on, and on its performance to date a reasonable person might conclude that its financial reporting lacks, shall we say, robustness.
Now who’d have thunk it? Well, lots of people, as the references in this earlier story attests.
Already you can discern the spin management coming from within the outfit and those caught awkwardly in its orbit.
You see, apparently all this failure is just a consequence of its remarkable success. The accounting problems are due to its rapid growth and the refund accruals problem is due to the fact that it’s selling higher up the food chain these days.
The money-bags at Morgan Stanley and JP Morgan both issued "nothing to see here" notes.
According to Morgan Stanley, “While the announcement creates additional negative noise, we believe it is a [one-time] impact, and a mild hiccup in Groupon’s long-term story.”
JP Morgan meanwhile suggested, “... we do not view the restated financials and internal process weakness as indications of fundamental softening in Groupon’s model, as indicated in the 1Q12 guidance affirmation. Instead we believe they reflect Groupon’s dynamic deal mix and the company’s extremely rapid growth in a very short amount of time…We believe Groupon shares could become more compelling if we see a significant sell-off related to the restatement.”
Now, hold on a moment? JP Morgan? Morgan Stanley? Groupon? Where have we seen those three names (along with several others) before in the same paragraph? Oh, that’s right, over here. Both companies were underwriters for the IPO, and indeed Morgan Stanley was one of the lead bankers, along with Credit Suisse and, you guessed it, Goldman Sachs. All of which makes Grok wonder what the Vampire Squid — a chief spruiker of the stock for IPO — has to say about the current shenanigans.
SteetInsider reported the firm said: “While the impact of the revision is minor, the need for it is a reminder that Groupon remains in the very early stages of development for a company of its size.” And that didn't stop Goldman dropping its target price for Groupon from $29 to $25 after the revision, although it has not yet adjusted its forward estimates, according to StreetInsider.
Not that Grok would ever suggest that any reputable firm would ever offer their clients advice that was contrary to the firm's own interests. But of course, others might.
So, the argument from all these companies is that these are all just growing pains and Groupon is simply a victim of its own essential excellentness.
Call it the Insolent Adolescent defence if you like, but there's a slight technical problem with this line of argument — it’s bullsh*t.
The tech sector traditionally does "spectacular growth profile" very well, so managing scale is hardly a new phenomenon. Lise Buyer, principal at Class V Group who advises startups on public offerings, told the Washington Post , “Re-statements and disclosures of material weaknesses are rare this soon after an IPO because the Securities and Exchange Commission requires detailed checks on financial controls before a debut.” The Post noted that “only 12 per cent of companies reported having ineffective financial-reporting controls within their first year of trading” — figures it obtained from data provider Audit Analytics which examined 1848 companies that held IPOs since January 2004.
The second leg to the defence is that the accrual failure was driven largely by higher returns for higher priced items. Groupon's cheer squad say this is evidence of Groupon garnering greater influence as it climbs the transactional food chain.
Or, perhaps not.
To Grok, it's simply evidence that its flawed model breaks down faster the further you move away from the impulse to buy. And don't forget that as the US economy improves, better brands will abandon discounting — because they can — which doesn't augur well for the daily deal makers.
Business Week quoted Groupon spokesman, Paul Taafe, admitting that “there is a certain amount of scepticism in the market” given the company's history, before he also trotted out the Insolent Adolescent defence.
But his best line was, “Every three months, Groupon is a different company.”
Oddly, that disclaimer was missing from Groupon's prospectus barely two companies ago.
Andrew Birmingham is the CEO of Silicon Gully Investments. Follow him on Twitter @ag_birmingham.
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