Reality Bites for Groupon

It seems so long ago now. But just over two years ago, Google (GOOG) offered to buy social buying site Groupon (GRPN) for a cool $5.3 billion, plus a $700 million earn out provision if certain business targets were achieved.  Groupon CEO Andrew Mason said no thanks, continued to build out the business and took the company public in November of 2011.

Groupon enjoyed a moon-shot debut as a publicly traded company. The online coupon service’s stock advanced 31% to $26.11 on its first day of trading, a level that valued the company at about $16 billion.

Mason’s decision to kiss off Google probably makes many Groupon employees wince these days, as the company is in a free fall.  As of December 27, Groupon’s stock is down 76% on the year and the company’s market value is all of $3.1 billion. Free cash flow has been shrinking all year and the company is one of the most shorted stocks on the NASDAQ.

GRPN Chart

GRPN data by YCharts

Covestor manager Barry Randall, who runs the Crabtree Technology portfolio, predicts Groupon will file for bankruptcy protection in 2013. “All you need to know is that in its most recent four quarters of business, Groupon’s quarterly cash flows have been $879 million, $38 million, $25 million and $15 million,” Randall noted in a recent post. “We don’t think you need a Wall Street analyst to tell you how this is going to end.”

GRPN Free Cash Flow Chart

GRPN Free Cash Flow data by YCharts

Turns out Groupon’s business model, so heralded two years ago, has deep flaws. Groupon sends outs massive email blasts offering steep discounts on everything from day trips to Vermont to a teeth whitening session. It takes a steep cut of the action from vendors on any new business they manage to attract.

Columbia Business School Professor Rita McGrath and others have pointed out that Groupon’s business model doesn’t create much brand loyalty among consumers (who pay nothing) or vendors and can be easily copied by rivals. That reality and slowing growth may make it difficult for Groupon to find a buyer in 2013 if it decides to put itself up for sale, according to this analysis by Bloomberg.

None of this seemed to matter much to Google and Internet investors two years ago. It sure does now.

Groupon (GRPN] is held in client accounts as of December 27, 2012. This investment may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.