Dude, Where's My IPO? The Groupon Founder's Lessons for Facebook

Posted by Mark Bergen


As he prepares for a monumental IPO of his own next week, Facebook’s Mark Zuckerberg could look to another young startup billionaire to see just how rough going public can be.

At a conference last summer, Andrew Mason, the CEO of Groupon, was asked about rumors that his company would soon sell its stock publicly. In response, Mason gave a “death stare”: His eyes widened and set, his mouth stayed shut. His interviewer let out a nervous chuckle, then tried again, only to be met with the same reply. A scatter of laughs erupted from the audience.

A year later, Groupon’s $13 billion IPO was the largest for any web company since Google, but Mason swiftly learned that he wouldn’t get laughs being as cagey as he was before. On Friday, shares of the Chicago company fell below $10, less than half the price when it went public. The drop erased $4 billion from its market value. Much of the tumble came after news broke last month that the SEC plans to investigate the fledgling tech company for its troubling accounting practices.

While Groupon and Facebook are in very different places, the daily deal company’s trouble justifying its growth strategy to the public serve as a warning to Zuckerberg and the investors who aim to value his company nearly 10 times as much as Groupon.

Mason’s IPO headaches revolve around an accounting flaw that has plagued his company since its birth. Each year, Groupon reports its total expenses and, like other companies, guesses how much money it will have to refund to dissatisfied customers. In 2010, that guess was around 2 percent of revenue. If that estimate is lower than what the company ends up paying out, the report artificially inflates the company’s value on the stock market.

In the year of its IPO, Groupon expanded its offerings in ways that made these accounting troubles worse. For its first three years, the deals it offered were fairly small—a haircut, a bowling game, a cheap dinner. Then it began to think much bigger: trips abroad, major surgeries, graduate school courses. Coupons became more exotic (a spa that specializes in fish pediatrics) and riskier (travel deals that may not pan out, or may mask hidden taxes). The result: Many customers cashed in on the Groupon Promise, the broad warranty that allows users to get their money back if the purchase goes poorly. Because many of these pricier deals were given as holiday presents, come January, Groupon saw a huge uptick in refund demands.

In March, the company released a statement admitting the flaw and revising its fourth-quarter revenue downward by $14.3 million—a little less than 3 percent of the overall income. Some accounting experts claim the problem will remain until Groupon revamps its reporting altogether.

The company's fuzzy accounting has come under the microscope before—in the lead up to the IPO, the SEC demanded the company revise its filing twice. This wobbly reporting tack, listing illusionary income that may never arrive, is likely the target of the upcoming SEC probe. On Monday, just days before Facebook’s IPO, Groupon will announce its first-quarter earnings for this year, which skittish investors will surely pore over carefully. Business analysts say the accounting misstep should not worry Groupon shareholders as much as concerns over whether the growth is sustainable.

"To my mind, the big issue in this episode is the evidence that they face strong headwinds expanding into the big-ticket market," says Ray Ball, an accounting professor at the University of Chicago Booth School of Business. “I am not a fan of Groupon's business model and can’t see them generating sustained growth in profitability that is implied by their current valuation.”

Market observers are concerned that the big-ticket items won’t rope in new consumers at the rate Groupon is projecting, and they’re afraid that the young company doesn’t have the managerial wherewithal to deal with rapid changes. Its own 10-K document put the matter to investors bluntly: “We cannot assure you that we will be able to manage the growth of our organization effectively.”

Facebook’s disclosures include a nearly identical phrase, and its accounting practices have attracted the same criticism as Groupon’s, so a similar skepticism surrounds the valuation of both companies. While buying Instagram was probably a step in the right direction, it doesn’t have a clear strategy for ad revenues with mobile users, where it expects its biggest growth. The company gains its value from extracting enormous amounts of information from its users. If it can’t find a way to monetize this information, or if users revolt, its value could quickly deflate.

Zuckerberg does have a clear advantage, and not just that the profitable Facebook doesn’t need its IPO to raise capital to fuel its growth. “Once you are on Facebook, it is costly to move to a competing service,” Ball says. “Groupon customers can switch easily to competing services, so the company has no similar way of locking its customers in.”

Still, once Facebook goes public, the company also must face the scrutiny of inquisitive investors.

Mason based his idea for Groupon on the famed sociological concept of the “tipping point”—build a critical mass, and the deals pay off. Facebook works much the same way. So does the stock market. As shareholders keep nervously trading their stakes, Groupon could remain in a downward spiral. One report noted how the share spill has opened up possibilities for smaller investors that passed on the price IPO back in November. But most of these investors aren’t biting. They're waiting for Facebook.

Photo via (cc) Flickr user TechCrunch