June 3, 2011, 11:46 AM

Groupon eyes growth with IPO

The company recognizes that it needs to grow and adapt to keep its daily-deal lead.

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Business history is peppered with frontrunners such as Netscape and Friendster that sprinted out to lead their respective fields but fell back into the pack because they failed to adapt to consumers’ evolving expectations. Groupon Inc., which yesterday filed to go public, doesn’t want to join their ranks, says Lou Kerner, vice president of equity research at Wedbush Securities.

That’s why the daily deal site spent $208.2 million on marketing in the first quarter of 2011, almost 80% of the $263.2 million the company spent in all of 2010. And it also explains why Groupon spent $203.2 million on acquisition-related expenses last year. Those expenses are necessary, says Kerner, because Groupon is in the midst of a global land grab as various players, including LivingSocial, Google and Facebook, each strive to capture bigger chunks of the daily-deal arena. For instance, LivingSocial earlier this week announced it had expanded in Europe by buying France-based daily deal site Dealissime.com.

“The daily-deal market is in its infancy,” Kerner says. “Groupon has a lot of work ahead of it. The competencies necessary to maintain leadership will be creating a bigger self-service model that enables businesses to create their own deals on the platform. They’ve got to adapt as the space becomes more social and more mobile. And they’ve got a lot of different acquisitions that are running on different platforms that need to be consolidated. There’s a lot of work ahead to maintain their leadership position.”

Groupon is the leading daily-deal site, according to web traffic measurement firm Experian Hitwise. In the week ending May 28 Groupon captured 76% of visits among 81 group-buying sites tracked by Hitwise.

Hitwise statistics also illustrate how fast Groupon has grown in the past year. Groupon.com’s share of all web site visits increased 564% when one compares the week ending May 28 with the same week in 2010.  

Key to sustaining that growth, Kerner says, will be new ways to offer deals such as Groupon Now, which consumers can use to find limited-time deals—that is, deals that last for hours, not months—to consumers based on where they are at the moment.

Groupon acknowledged that challenge yesterday in its S1 filing with the U.S. Securities and Exchange Commission in advance of the company’s initial public offering. While the filing is for $750 million, many analysts, including Kerner, believe that the value will increase before investors can actually buy shares of the company. “They want to create a demand for Groupon shares, then once they see what that demand is, they’ll likely upsize the value,” he says. While Kerner is unsure what that new value might be, he notes that $750 million is “a big number” and the upsized value will likely be even larger.

However, to sustain its value Groupon notes that its continued revenue growth depends on its ability to acquire new subscribers, persuade its current subscribers to buy more vouchers, expand its merchant relationships, bolster its brand awareness and respond to changes in how consumers access the Internet.

“We expect that the market will evolve in ways which may be difficult to predict,” the company notes in its filing. “For example, we anticipate that over time we will reach a point in most markets where we have achieved a market penetration such that investments in new subscriber acquisition are less productive and the continued growth of our gross profit will require more focus on increasing the rate at which our existing subscribers purchase Groupons. It is also possible that merchants or customers could broadly determine that they no longer believe in the value of our current services or marketplace. In the event of these or any other changes to the market, our continued success will depend on our ability to successfully adjust our strategy to meet the changing market dynamics.”

Undoubtedly Groupon will continue facing stiff competition. But some analysts, including Greg Sterling, founder of Sterling Market Intelligence, believe that the company will succeed because it understands what it needs to do.

“There are a couple hundred companies doing something similar to Groupon but Groupon is one of the few brands that people recognize in the space,” he says. “And it’s not a zero-sum game. Even if someone buys a voucher from another company they still can buy a Groupon. Groupon is a smart company that is very aware of the challenges and limitations of its business.”

Proof of that awareness, he says, is the fact that the company recognizes that its sales force is responsible for its success. That’s why roughly half of Groupon’s 7,107 employees work in sales.

“That’s a stark contrast to the Facebooks and Googles of the world,” he says. “It’s unusual because that’s the old-fashioned way of doing things. In a way Groupon has more of a traditional media mentality. That model is traditional because it is often necessary. We’ve seen companies fail because of their absence of an active sales force.”

That sales force has helped propel Groupon’s revenue growth. The company says it had $644.73 million in revenue in the first quarter of 2011, up from $44.24 million a year earlier. The company’s 2010 revenue was $713.4 million, more than 20 times its 2009 revenue of $30.5 million.

With the IPO, investors will decide whether they believe Groupon will continue to grow, says Kerner.  “Investors will focus on one question, ‘Can Groupon sustain its leadership position?’ If they believe it can its value will quickly rise,” he says. “But whether it can sustain that value remains to be seen. We’ve seen enough early leaders become also-rans to know that anything can happen.”

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