Groupon is a terrible company for investors — but I’m buying shares tomorrow

If you’d told me 5 months ago that I would spend a lot of 2011 studying accounting, talking to businesses and saying bad things about a company that everyone once loved, I never would have believed you.

It all started at Floyd’s Coffee in the Old Town section of Portland — which, ironically, was running the very first Google Offer. I had planned to spend the day there to understand what customers thought of Google Offers, how many people came in and how they interacted with the staff. At that point, I’d spent very little time looking at the space. That day, Groupon put out its first S-1. The company is now poised to go public tomorrow with an initial share price of $20.

The first analysis I read, by a supposed expert in the local space, raved about the company. He essentially pulled all of management’s talking points and put them in the story. I knew the company was nowhere near as good as the picture he painted, but I didn’t know how bad it would turn out to be.

Five months later, I’m more convinced than ever that this is a terrible company for investors, small businesses and ultimately for consumers. Unless the company substantially changes its business model, investing in Groupon will be like investing in a leaky bucket.

Among the significant challenges I see:

The daily deals business is past its peak. The best days for the classic Groupon are in the past. With its 3Q results, Groupon has largely proven that once it slows spending on marketing, growth stops. In its most established markets, Groupons sold are down more than 10%. In Boston, the number of merchants featured in 3Q is down a whopping 20 percent. Some look to Asia for expansion, and sure, Groupon can expand there. But the share of revenue it gets to keep in Asia is substantially lower than in the U.S. and Europe.
The only area where Groupon seems to be able to innovate is accounting practices. New product lines like Groupon Getaways and Groupon Goods are retreads of long-established e-commerce categories. Groupon’s entries in these categories show zero innovation. In many cases, they are turning back the clock 10 years. In 2011, I shouldn’t have to call to make a hotel reservation.
The future is all about targeting and self-serve. Smart businesses don’t want to blast a spam message to everyone in a region who might want a cheap massage. If I ran a spa, I’d want to reach people within 5 miles of my business who weren’t already customers and who regularly spend money on spa services. I want qualified customers, not those who are “once and done.” And I certainly don’t want to discount to people who would pay full price. The Groupon daily deal model doesn’t support this. Once you target to this level, the volume and revenue on each deal is too low to support a sales force. The Groupon army that some people view as a moat will turn out be an anchor.
The future is mobile. People will search for, purchase and redeem offers on mobile devices. Google and Facebook have a huge advantage in mobile. They already have hundreds of millions of people using their apps. Although Groupon Now is an OK product, it has little distribution. To be a player in this space, Groupon would have to buy distribution. It will essentially have to pay to re-acquire customers. Then it has to hope that those people will change their usual behavior and go search in a separate app. Google’s launch today of its Android Offers app should terrify Groupon investors. Google could include Offers as a pre-load in Android. Or it could surface the offers into Google Maps — something that people already use.
The management team seems to be incompetent. They made up new accounting metrics. They ignored quiet period rules. They used a restaurant in their roadshow as a reference, apparently without checking to see if the restaurant would say positive things. (The restaurant didn’t.) Management told employees they could sell on the day of the IPO. (They can’t.) They asked me to name confidential sources in exchange for access to the Groupon building.
All of that said, I’ve put in my request with my broker for shares in the IPO because Groupon has scientifically engineered its IPO to inflate share prices. Its float is one of the tiniest in the last decade. Most likely this thing will have a nice pop tomorrow.

If Groupon’s stock skyrockets tomorrow, it doesn’t mean I’ve been wrong about the company. But in the unlikely event it tanks, it’s a big sign that I’m right. (I realize that this might sound like the kind of thing that Groupon’s accountants would say, but it’s true.) We’ll need to wait at least 9 months to really know.

Maybe Groupon will find a real business model in that time.

I’d like to thank a few people whose help has been invaluable in all of my Groupon coverage: Jonathan Gaw, Ed Ketz, Mark Rogowsky, Brian Roemmele, Conor Sen, Semil Shah and Rick Summer. They’ve read early drafts, provided valuable insight into areas that I’m not an expert in and helped to keep me in check.

On the media side, I’d like to thank Dylan Tweney, Heather Kelly and Mo Marshall at VentureBeat; Herb Greenberg and Juliet Mendez at CNBC; Emily Chang, Cory Johnson and Diane Anderson at Bloomberg West; and Erick Schonfeld at TechCrunch.

Rocky Agrawal is an analyst focused on the intersection of local, social and mobile. He is a principal analyst at reDesign mobile. Previously, he launched local and mobile products for Microsoft and AOL. He blogs at blog.agrawals.org and tweets at @rakeshlobster.

Here’s a video of Agrawal discussing the Groupon IPO on CNBC.

This story originally appeared on Agrawal’s blog.