IPOs: Doomed to fail?
- 10 April 2012
But the gloves had already come off for Groupon; Josh Brown on The Reformed Broker had labelled the group's IPO ‘a disgusting scam', saying it was ‘designed by the underwriters to present the appearance of a hot deal so that they can get Mark Zuckerberg's attention for the real IPO coming next spring. Share counts were kept low for the media to see a "pop" – and then backs were turned as the market cap was cut in half over 24 days. Everyone involved should be ashamed of themselves.'
His damning conclusion? "As though coupons delivered electronically (and unprofitably) is some major advancement of human civilization worthy of being priced at 5 times sales. Are you people high?"
He has continued his attacks, supported by an ex-employee of Groupon, who claims he was unfairly dismissed for revealing details of the internal workings of the company.
Certainly, the scandals attached to Groupon have now been well-flagged. Its problems have been picked up by the mainstream media and have had a material effect on the share price, which is now almost half its level at IPO.
"Groupon shares fell 17 percent on Monday, after the online coupon company said late last week that it had identified a "material weakness" in its internal controls over financial reporting, as of Dec. 31. The Chicago-based company also revised its fourth-quarter results to show lower revenue and a larger loss, after finding errors in its accounting for customer refunds. At $14.54, the stock now sells for 44 percent less than it did after the first day of trading."
Bloomberg points out that Groupon had no obligation to disclose its accounting weaknesses in its IPO documentation – though this will be tested in the Fan Zhang case – and would only have had to disclose the problem when it filed its first quarterly or annual report as a public company.
Morningstar has Groupon as a ‘sell'. Paul Larson, Chief Equities Strategist and Editor of Morningstar StockInvestor and Rick Summer, CFA, CPA, Equity and Credit Analyst say: "The company does not appear to have an economic moat, and even after falling after the IPO, the stock still looks richly valued. Caveat emptor!"
They say that Groupon's business presents investors with three critical challenges: 1) The business does not scale well. 2) Short-term advantages are neither durable nor profitable, and 3) The business model is unproven, leading to a wide range of potential outcomes for the company's overall valuation.
It says that Groupon's cost base is heavy, its business can be easily replicated and customers and merchants have no switching costs. The firm has no cost advantage and has no meaningful intangible assets: "Groupon is essentially a sales agent and intermediary between local merchants and consumers. Consumers are free to use competitors such as LivingSocial, Amazon Local, or Travelzoo's Local Deals and gain little to no benefit from using Groupon repeatedly. Moreover, LivingSocial has shown no signs of slowing growth although it has a smaller base of merchants and customers."
Ok, so Groupon sucks, but does this have any implications for the wider social media universe and its dalliance with Wall Street?
This piece from Felix Salmon on Wired points out the problems of going public for a growing company: "Going public might be good for a company's investors and employees, but it is usually bad for the company itself. It forces CEOs to focus on short-term stock fluctuations at the expense of long-term growth. It wrests control from the founders and gives it to thousands of faceless shareholders.
"For hugely successful mega-businesses-Apple, Facebook, Google-going public has its benefits. Public companies enjoy cachet, tax advantages, and access to more and better financing options. But for many young companies, the drive to go public results in a death spiral of unsustainable growth."
This sentiment is echoed in an article in Venturebeat : This suggests that the post-IPO stock performance of venture-backed technology companies over the past two years in the aggregate has been poor, when compared to the standard benchmark of the S&P 500 Index. It gives details of around 80 companies, saying that "combined return for all offerings in the aggregate was a dismal -2.2 percent, compared to the S&P 500 index, which returned 15.5 percent for the same period."
This piece asks the same question but comes to a slightly different conclusion: "If you're in the market for a quick buy and sell, then social media companies seem like a stronger pick. Anything remotely long-term though, and they seem to quickly lose their lustre."
Kevin Murphy, co-manager of the Schroder Recovery and Income funds says that investing in IPOs of all kinds has its limitations : "Companies looking to float only have to offer details of the preceding three years – and, since management only float at the top, these are highly unlikely to include any bad years.
"Similarly, a meaningful analysis of a cyclical business will sometimes involve looking beyond the last five or so years. After all, mining has enjoyed an almost uninterrupted run of success since 1998 so a thorough understanding of the sector can really only be gained by going back far enough to include some ‘down' years."
Social media groups are the glamour stocks of this generation. Yet the Groupon experience should make investors savvy to their limitations.
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