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Groupon IPO: Don't Expect a Discount

When Groupon passed on an opportunity to sell itself to Google for $6 billion, its decision appeared to make a lot of sense. But a $25 billion valuation for a three-year-old startup that had less than $1 billion in revenue last year is a stretch.

A $25 billion valuation for a three-year-old startup that had less than $1 billion in revenue last year is a stretch — even if that company is Groupon.

True, the Chicago-based company has pretty much transformed the world of online shopping during the last three years by pioneering the use of daily deals for members in cities and towns around the U.S. and elsewhere. It has put a new twist on digital commerce and established a lead in the market where everyone wants to be — local online advertising. Even better, it has a clear business plan and generates cash. Unlike many a startup that has backed into its business model.

When it passed on an opportunity to sell itself to Google for $6 billion, its decision appeared to make a lot of sense. Google CEO Eric Schmidt was said to have been prepared to pay up to $10 billion.

Now, it appears the company is headed for an IPO sometime this year with a valuation of $25 billion, according to Bloomberg BusinessWeek, which broke news of the plan. What could possibly justify such a valuation? At the moment, it’s a stretch, even for Groupon.

“It’s a good market now — there are similar companies like Priceline out there that have outrageous valuations which help to support the notion that Groupon could be ‘bargain’ at such a crazy valuation,” says analyst Sucharita Mulpuru of Forrester Research. Priceline.com shares are trading at $452.19, up 86 percent over the last 52-weeks. The company has a trailing PE of 42.9 “The truth, though, is that there is very little history that the company (Groupon) has around its growth rate, and the past rate of growth has come through acquisition. It’s just not sustainable,” she said.

Yes, Groupon has plenty going for it. Since the Google offer was made in December, Groupon has doubled its users to 70 million and boosted the number of markets where it operates to 500 from 300, according to Bloomberg. The company, led by 30-year-old-founder Andrew Mason, had $760 million in revenue last year, up from $33 million in 2009, the Wall Street Journal reported.

Yet, with a valuation of 30 times last year’s revenue, Groupon is expensive, indeed. Like Twitter and Facebook, its valuation is driven by the arrival of Internet Bubble 2.0, which encompasses many obscure startups, as well as a few well-known Internet giants. Twitter is now valued at $7.7 billion, twice as much as the $3.7 billion valuation it commanded only in December. Facebook’s valuation has climbed to $75 billion in the private market, up from a then-astonishing $50 billion in January. It’s not just the valuations that are alarming — it’s the pace. The market doesn’t know that much more about these companies now than it did just a few months ago. Groupon is now being valued in the same way.

Google, in comparison, is valued at $190 billion. But it has $29 billion in profits. And Google went public at a valuation of about 23 times trailing revenue.

A Groupon IPO will generate a fortune for early investors. The company was founded in 2008 with $1 million in seed money from Mason’s former boss, entrepreneur Eric Lefkovsky. It has raised venture capital from Accel, Battery Ventures, New Enterprise Associates, and Digital Sky Technologies, which has invested in Facebook.

Later stage investors should be mindful of the company’s challenges, though. For starters, it already faces plenty of competition, including rival LivingSocial, which counts Amazon among its investors.

There is a deeper challenge, though. A Rice University study found last fall that consumers generally are happier with Groupon than are the businesses that use its platform to offer discounts. “Groupon promotions were profitable for 66 percent of the businesses surveyed for the study, but they were unprofitable for 32 percent. More than 40 percent of the respondents indicated they would not run such a promotion again,” the Rice study said.

Says Mulpuru: “Businesses aren't enamored of the current approach, which is a 50-50 split off a 50 percent-off or more offer. Those margins will go down over time especially for the attractive businesses.”

And she says the competition — already significant — could become much more serious. “Living Social and the other Groupon clones aren't the only threat — there's the threat of businesses offering these deals themselves, or other players like media companies getting in to the business successfully,” Mulpuru says.“The hope is that there are enough investors tolerant of risk to give Groupon a try, or at least enough people who think they can persuade others that Groupon is worth the valuation to at least cash out before reality sets in.”

Whether the company grows into its valuation isn’t an issue for early investors, as long as they can realize a profit. But for later investors — especially those in an IPO — the strength of the long-term case for Groupon matters a lot.

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