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Cutera, Inc. (CUTR)

Groupon's $540 Million Loss May Leave Investors Leery of IPO


By: Ari Levy | June 02, 2011

Groupon Inc.’s $540.2 million in operating losses since 2008 may leave some investors leery of buying shares in a company with a business model so easy to copy that it has spawned 482 imitators.

Groupon, the biggest provider of online daily-deal coupons, said yesterday that it plans to raise $750 million in an IPO, the most yet for a U.S. social media company.

Sales surged more than 14-fold to $644.7 million last quarter, making Chicago-based Groupon bigger than established technology companies like Citrix Systems Inc. (CTXS) and Autodesk Inc. (ADSK) Yet, with marketing costs rising faster than sales, Groupon may not make money fast enough to warrant the $25 billion valuation it was said to be contemplating in March, said Pat Becker Jr., a portfolio manager at Becker Capital Management Inc.

“Companies have to have profitability or a compelling case for a path to profitability,” said Becker, whose Portland, Oregon-based firm manages $2.5 billion. “We also look for barriers to entry and we just don’t see that in this particular business.”

Co-founded in 2008 by Andrew Mason, Groupon has ballooned in the past year as consumers worldwide flock to daily offers for discounts of up to 90 percent at hotels, restaurants and nail salons. The company’s gross profit, or the revenue left after sharing sales with merchants, jumped to $270 million in the first quarter from $20 million a year earlier.

‘Revolution in Retailing’

The daily-deal market pioneered by Groupon may generate $3.9 billion in U.S. sales in 2015, from $873 million in 2010, according to researcher BIA/Kelsey in Chantilly, Virginia.

Subscribers increased to 83.1 million in the first quarter from 3.4 million a year earlier, and the number of deals sold jumped to 28.1 million from 1.8 million. Groupon delivers coupons in more than 500 markets worldwide, compared with 260 for its top competitor, Washington-based

“The whole deals space is the most revolutionary thing in retailing since the advent of e-commerce,” said Lou Kerner, managing director of the private shares group at Wedbush Securities Inc., in a televised interview on “Bloomberg West.” “This is a market that is going to be really, really big but it’s still really in its infancy.”

To handle the growth, Groupon bolstered its workforce to 7,107 employees as of March 31, from 37 in June 2009. Revenue per sales representative in the first quarter was $172,000 a month, up from $87,000 two years earlier, the company said.

The company had marketing costs of $208.2 million in the first quarter, resulting in a net operating loss of $117.1 million. Groupon spent $179.9 million on subscriber acquisitions, as it tries to build its lead over LivingSocial.

Profitability In Question

“Since our inception, we have prioritized growth, and investments in our marketing initiatives have contributed to our losses,” Groupon said in the filing. “Over time, as our business continues to scale and we become more established in a greater percentage of our markets, we expect that our marketing expense will decrease as a percentage of revenue.”

The size of the marketing budget will make it difficult to reach profitability any time soon, said A.B. Mendez, a research analyst at GreenCrest Capital Management LLC in New York.

“It’s not yet clear what their longer-term margins will be or when they will be able to get to consistent profitability,” Mendez said.

LinkedIn Corp., the No. 1 professional-networking site, last month became the first major U.S. social-media company to sell shares to the public. Shares of the Mountain View, California-based company have surged 75 percent since its May 18 debut and now has a market value of $7.5 billion.

Cheaper Than LinkedIn?

On a price-to-sales basis, Groupon may be cheaper than LinkedIn and Facebook Inc. LinkedIn is valued at 20 times this year’s sales, assuming first-quarter revenue is replicated throughout the year. A $25 billion valuation for Groupon would mean a price-to-sales ratio of 9.7. Facebook is valued at $55 billion on the secondary exchange SharesPost Inc., implying a ratio of about 13.8.

To justify its valuation, Groupon needs to convert marketing costs into profit by ensuring customers keep coming back, said Espen Robak, president of Pluris Valuation Advisors LLC, a New York-based adviser to investment funds.

“It all depends on how sticky those customer relationships are,” Robak said. “If they become subscribers forever and you can harvest those relationships for a long time, the money you spent up front is money well spent.”

Internet music service Pandora Media Inc. said yesterday that it plans to raise as much as $123.2 million in an IPO. At the midpoint of its range, the company would be valued at $1.27 billion, or 6.2 times revenue.

Shareholder Backers

The biggest shareholder is Green Media LLC, which is owned by co-founder Eric Lefkofsky and his wife, Elizabeth Kramer Lefkofsky. Green Media owns 21.6 percent of Class A shares and 41.7 percent of Class B stock.

Rounding out the list of top investors are Rugger Ventures LLC, owned by the family of Groupon co-founder Bradley Keywell, which holds 6.9 percent of Class A stock and 16.7 percent of Class B. New Enterprise Associates and Accel Partners own 14.7 percent and 5.6 percent of Class A shares, respectively.

Investors with less than 5 percent ownership include T. Rowe Price Group Inc., Andreessen Horowitz, Greylock Partners, Russia’s Digital Sky Technologies and Kleiner Perkins Caufield & Byers. Bloomberg LP, the parent company of Bloomberg News, is an investor in Andreessen Horowitz.

Groupon was valued at about $1.3 billion in April 2010, when it raised $135 million from Digital Sky and other investors. An investment of $950 million, completed in January, pegged Groupon’s worth at $4.75 billion.