Groupon's fall to earth swifter than its fast rise

NEW YORK (AP) — Only a few months ago, Groupon was the Internet’s next great thing. Business media christened it the fastest growing company ever. Copycats proliferated. And investors salivated over the prospect of Groupon going public.

Today, the startup that pioneered online daily deals for coupons is an example of how fast an Internet darling can fall.

Groupon is discounting its expectations for the IPO that in June was valued as high as $25 billion. In a regulatory filing Friday, the company said that it expects a valuation that is less than half that at between $10.1 billion and $11.4 billion.

It’s the latest twist for Groupon’s IPO, which was one of the most anticipated offerings this year. In June, after Groupon filed for the offering, the SEC raised concerns about the way it counts revenue. Then the stock market plunged.

Now Groupon faces concerns about the viability of its daily deals business model. The novelty of online coupons is wearing off. Some merchants are complaining that they are losing money — and customers— on the deals. And competitors are swarming the marketplace.

“Groupon is a disaster,” says Sucharita Mulpuru, a Forrester Research analyst. “It’s a shill that’s going to be exposed pretty soon.”

Groupon shows what can happen when a startup experiences steroidal growth in an unproven industry. To its defenders, the Chicago company is a victim of its success, its stumbles emblematic of a business in infancy. After all, Groupon has hordes of fans who rave about the company’s deals and its liberal refund policy. And some merchants see the company has a way to get much-need exposure.

“It’s free marketing and it brings in a lot of people,” says Cono Moreno, owner of Brooklyn’s Verde restaurant.

But critics say the issues Groupon is facing are symptomatic of something more troubling: questionable accounting, an overvalued business model and an industry that is turning into the digital equivalent of junk mail.

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.

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.

By 2010, Groupon was in nearly 100 cities and 25 countries. Groupon’s staff ballooned to nearly 10,000. Mason, now 30, was on his way to becoming the next tech billionaire.

The scene was set for an IPO. In June, Groupon filed documents with the SEC reporting $713.4 million in revenue in 2010, making it the first company to surpass the $500-million revenue mark in its third year, according to Forbes magazine. But Groupon began facing a growing perception that its business was unstable.

The online deal space was getting jammed with competitors, like Living Social, Amazon.com and Google. They are among the many copycats who are attempting to do what Groupon does. Big merchants are also running their own daily deals online.

At the same time that competition is building, consumers are questioning the quality of Groupon’s offerings. Those who are disgruntled with Groupon often broadcast it on Yelp, the user review website that rates merchants. There’s even something called the “Yelp Effect,” named for the way angry customers drive down the merchants’ Yelp ratings.

“Most of the deals are for female-centric services like spas and nails or for high-ticket non-necessities like skydiving and travel,” says Richard Breen, a Greenville, S.C., marketing executive who used to use Groupon. “I typically delete it each day now without opening the email.”

When she first started using Groupon in 2008, Sabrina Kidwai, of Alexandria Va., was happy with the deals site. But then she used a Groupon for a picture canvas for a family photo. She placed the order three days before the Groupon’s expiration, but the merchant was so overwhelmed with the response to the deal that it couldn’t fulfill her order. What ensued was a customer service nightmare that ended with Kidwai getting her picture canvas two months later.

“I definitely think there are some wonderful deals, but users really need to pay attention and speak up when the company provides you with a bad experience,” she said.

Adding to growing customer discontent, Groupon, which was initially seen by small mom-and-pop shops as a way to drum up new business, was losing favor with some of them. Merchants began to do the cruel math on the daily deals.

Restaurants offering $50 of food for just $25 only collect $12.50 — not even enough to cover the cost of the food. Some businesses also complain that the deals for new customers anger long-time patrons. Others say that the bargains attract high-maintenance types who don’t turn into loyal customers.

“Your restaurants are full packed with people who aren’t making you any money,” says Paul Evans, a Kansas City marketing executive who advises clients against using Groupon.

Take Jessie Burke, for instance. Last year, the owner of Portland’s Posies Café offered a $13 coupon for $6. The café was deluged with customers and Burke ended up having to take $8,000 out of personal savings to cover payroll.

“It is the single worst decision I have ever made as a business owner,” Burke said in a blog post that quickly went viral.

Andres Arango, founder of natural jewelry company muichic.com, had a similar experience. He sold 80 coupons — $35 of jewelry for $15 — in two days. But of that $15, he only got $7.50. And he still had to dole out $35 worth of jewelry.

As far as customers? “They never came back,” Arango said

John Byers, a Boston University computer science professor who conducted a study on thousands of Groupon deals, wrote that he found that “Offering a Groupon puts a merchant’s reputation at risk. The audience being reached may be more critical than their typical audience or have a more tenuous fit with the merchant.”

Groupon also has faced trouble behind its own doors.

After only two months, its public relations chief quit in August. The next day, CEO Mason wrote a 2,500-word email to the staff defending Groupon against critics. That email was leaked to the press and then lambasted by some analysts and members of the investment community for violating terms of the quiet period.

Two seasoned executives hired as COOs also left. The latest, former Google sales vice president Margo Georgiadis, resigned after five months to return to Google. Her departure coincided with Groupon’s announcement that it was restating its revenue by around half.

“It’s like watching a Ben Stiller movie and waiting for the next painful moment,” says Mulpuru, the Forrester analyst.

The next chapter

After Groupon filed documents for its IPO in June, the SEC — and the investment community — began asking serious questions about the company.

The first concern stemmed from how Groupon accounted for its revenue.

Groupon roughly splits the money it collects from customers with merchants. But in the filing, Groupon reported all of its gross billings as revenue. Standard accounting principles dictate that Groupon should have used net revenue — the amount it keeps after paying the merchant.

For example, Groupon reported $1.52 billion in revenue for the first half of 2011. But after the SEC questioned it, Groupon in late September submitted new documents that showed that net revenue in the first half of this year was actually $688 million. Groupon was overstating its revenue by roughly half.

Groupon’s growth has no doubt been quantum. Since November, 2008, it has signed up 142.9 million email subscribers and has had more than 30 million customers. But only 20 percent of subscribers have purchased a Groupon. And only 10 percent have purchased more than one.

Groupon also faces concerns about how it has used its money.

On Oct. 7, in its fourth amendment, Groupon disclosed that it had spent half its net revenue — $345.1 million — on marketing costs alone during the first half of this year. Analysts think of those costs as how much Groupon is paying to acquire subscribers.

Additionally, there are questions about how the company has used investor money. Traditionally, investor money is used to grow a business before it goes public. But according to Groupon’s SEC filings, $810 million of the $946 million it raised went to early investors and insiders. That includes $398 million to Groupon’s largest investor, shareholder and executive chairman, Eric Lefkofsky.

“Taking this money raises questions about the integrity of the company and enormous questions about the quality of the management team,” says Mulpuru. “Groupon’s primary problem first and foremost is greed.”

Meanwhile, the company’s debt has skyrocketed. Groupon’s ratio of debt to capital is 102 percent. By comparison, the ratio for social-networking site LinkedIn is about 30 percent and gaming site Zynga’s is about 49 percent. “Those companies are all in normal territory,” says Ed Ketz, a Penn State accounting professor. “But Groupon’s is excessively high.”

In Friday’s filing, the company laid out third-quarter financial figures that showed it is getting closer to profitability. For the three months ended Sept. 30, Groupon narrowed its net loss of $10.6 million on revenue of $430.2 million in part by lowering marketing spending. That compares with a loss of $49 million on revenue of $81.8 million in the same period last year.

Groupon, which rejected a $6 billion takeover offer from Google Inc. last year, disclosed in the Friday filing that its revenue has grown from $1.2 million in 2009’s second quarter to $430.2 million in the third quarter of this year.

The company has its supporters. Groupon has been funded by such venture capital heavyweights as Andreessen Horowitz, firm of Netscape founder Marc Andreessen. Andreessen declined to comment, but in an August essay in the Wall Street Journal, he wrote that companies like Groupon would “eat the retail marketing industry.”

“We are in the middle of a dramatic and broad technological and economic shift in which software companies are poised to take over large swaths of the economy,” he wrote.