August 10, 2011, 12:55 PM

The growth curve slows for Groupon

The daily deal leader reports a 186% increase in net loss for Q2 as revenue growth slows.

Zak Stambor

Managing Editor

Lead Photo

Groupon Inc.’s net loss increased to $102.7 million in the second quarter, up 186% from the same period a year ago, as revenue growth slowed, according to an amendment filed today to the daily deal provider’s initial public offering.

The filing, which also seeks to clarify Groupon’s accounting practices, says revenue increased to $878.0 million in the second quarter. That is up 36.2% from $644.7 million in the first quarter of 2011 and up 905.7% from $87.3 million in the second quarter of 2010. While that represents strong growth, the most recent revenue growth rate is significantly less than the 62.6% sequential growth the company posted in the first quarter. Moreover, the group-buying site’s second quarter net loss marks a 186.1% jump from its $35.9 million net loss in the same period a year earlier.

Groupon says that as of June 30, it had 115.7 million subscribers—a number that the company expects to continue to rapidly increase throughout the rest of the year. However, acquiring those subscribers is costly, the company notes. Groupon spent $345.1 million on online marketing initiatives aimed at acquiring new customers in the first half of the year. “We must continue to retain and acquire subscribers that purchase Groupons in order to increase revenue and achieve profitability,” reads the filing.

Acquiring more customers could present pitfalls because they could change the makeup of Groupon’s subscriber base, the company notes. “It is possible that the composition of our subscribers may change in a manner that makes it more difficult to generate revenue and gross profit to offset the costs associated with acquiring new subscribers,” reads the filing “For example, if we acquire a large number of new subscribers who are not viewed as an attractive demographic by merchants, we may not be able to generate compelling products for those subscribers to offset the cost of acquiring those subscribers. If the cost to acquire subscribers is greater than the revenue or gross profit we generate over time from those subscribers, our business and operating results will be harmed.”

Groupon remains the clear leader in the group-buying space, says analyst Greg Sterling, founder of Sterling Market Intelligence. “But its costs are still high, and long-term the business as currently structured is not sustainable with those losses.”

One way Groupon has sought to diversify its offerings is via Groupon Now, a self-service model that enables merchants to offer nearby consumers limited-quantity, time-specific deals. However, Sterling says Groupon Now promises no significant benefit for Groupon. “Self-service has never been successful,” he says. “If you leave it up to merchants they will do a poor job. They have so many competing marketing options for them, and so many channels coming after them for attention and marketing dollars that it’s overwhelming. That’s why I think it’s unlikely that GrouponNow will be the salvation of the company.”

What will help Groupon’s future profitability, he says, is making the daily deal service more enticing for merchants, who receive only about half of the revenue generated from each voucher sold. However, those types of changes could eat into Groupon's profits.

Today’s amendment to the initial public offering also reduces references to Groupon’s unusual accounting practices, such as a metric that removed items like its subscriber-acquisition costs from its bottom-line results. “We don’t measure ourselves in conventional ways,” the company notes in the filing. Groupon says it internally tracks three metrics—gross profit, free cash flow (the net result of its cash flow from operations minus capital expenditures) and adjusted consolidated segment operating income (ACSOI).

The initial filing focused on ACSOI, which gauges the company’s consolidated segment operating income reported under standard U.S. accounting rules before it subtracts out its subscriber-acquisition costs. “We exclude those costs because, unlike our other marketing expenses, they are an upfront investment to acquire new subscribers that we expect to end when this period of rapid expansion in our subscriber base concludes and we determine that the returns on such investment are no longer attractive,” reads the filing.

The new filing notes that of the three internal measures Groupon tracks, gross profit is the key indicator to consider because it reflects the value merchants find with its business. In 2010 and the first half of 2011, the company generated gross profits of $280.0 million and $611.0 million, respectively.

That emphasis on gross profit isn’t surprising because it is another way to focus investors’ attention on top-line growth, says Sterling. “But if dig into the numbers you see that there are enormous costs associated with that growth,” he says.

Groupon CEO Andrew Mason notes in a letter accompanying the filing that the IPO is not without risk. “As with any business in a 30-month-old industry, success for our investors is not guaranteed,” he writes. “We have yet to reach sustained profitability and we have no shortage of competition.”

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