) was forced to restate fourth quarter earnings, sending its stock
down 6% in after-hours trading. This surprised me as much as my $2
investment in the Mega Millions jackpot not paying off.
The reasons for Groupon's restatement were higher refund
reserves and weakness in internal controls. These are issues I've
repeatedly discussed. I raised them directly with Groupon PR in
September (back when they still would speak to me) and I was
assured that refunds weren't an issue for Groupon.
I also spoke with a former Groupon salesperson who claimed he
was fired because he raised concerns about poor internal systems
that didn't track deals correctly and complaints about poor risk
management when it comes to running deals.
So what's happening at the coupon company?
Well, for starters, it's not a coupon company nor a marketing
company. At its core, Groupon's U.S. business is a receivables
factoring business, as I wrote last year. They give loans to small
businesses at a very steep rate (the price of the discount plus
Groupon's commission). They get the money to fund these loans from
credit card companies such as Chase Paymentech. Groupon is
essentially a sub-prime lender that does zero risk assessment. And
as word continues to spread about what a terrible deal running a
Groupon is for many categories of businesses, the ones that will
choose to run Groupons are the ones that are the most desperate.
For U.S. based businesses, the only time I can definitely recommend
running a Groupon is if it is otherwise going to go out of
Another factor is that Groupon is selling bigger and bigger
deals and many of these have requirements for use. Some deals have
medical qualifications. The former salesperson told me about
Groupons for a procedure called
. In this procedure, fat is frozen off the body. In order to get
the treatment, patients must be medically qualified. But Groupon
has no way of medically qualifying purchasers and will sell it to
anyone. When they go to the doctor and find out that they aren't
eligible, they call Groupon for a refund. If this is several months
later, after Groupon has paid out the entirety of what it owes the
provider, this can mean a refund loss for Groupon.
Travel is another risky category for Groupon. Unlike Expedia (
), Travelocity, Priceline (
), Jetsetter and nearly every other major travel provider, Groupon
does not require consumers to pick their dates and confirm
availability at the time of purchase. When a consumer finds he
can't use his Groupon months later, he calls for a refund. Groupon
hides material restrictions on travel deals
, something I pointed out in September and Groupon still hasn't
Because these are higher ticket items that cost hundreds or
thousands of dollars, consumers are more likely to ask for a refund
than on lower ticket items. In the short term, it means a revenue
boost to Groupon, which the company needs as its once torrid growth
itself cools. In the long term, it means refund losses.
The "Groupon Promise" is another risk factor. It's an overly
broad promise designed to allay consumers' concern about using
Groupons. Because it is so broad, it results in higher refund rates
than would otherwise be the case.
Yet another concern is that Groupon does not track how much
outstanding Groupon "debt" there is. There is no one in the world
who can tell you how many and how much Groupon value is
typical gift card sales
, Groupon books revenue immediately and then does not show the
Groupons on its balance sheet. By my estimates, Groupon has between
$500 million and $750 million in liabilities that it doesn't show
on its balance sheet.
In theory, Groupon's exposure to that risk is covered by its
refund reserves - but we don't know the size of those reserves. And
as yesterday's restatement shows, they've calculated them poorly.
Unless Groupon begins to do risk assessment on deals before they
run, changes its payout terms to businesses or drastically changes
its refund policies, I expect refund rates to continue to rise. If
they do any of those things, I expect revenue declines because it
will make running Groupons less attractive to businesses and buying
Groupons less attractive to consumers.
Groupon has also worked hard to hide their refund rates. While
going through their S-1 process last year, Groupon continually
revised its accounting. At one point, I discovered a way to
calculate their refund rates and
found that refund rates had likely increased more
than 40% year-over-year
. In the next amendment to their S-1, they changed their accounting
again to bury that data.
Investors should also be concerned about the fact that Groupon's
lock up should end in early May, releasing a lot more shares on to
the market. I wouldn't be surprised to see Groupon trading in
single digits after that and heading to zero within the next 36
months. Groupon's best bet is if they can acquire their way into a
sustainable business model; I'm doubtful that will happen
considering the companies they have purchased to date.
With its restatement, Groupon said that its guidance for the
first quarter remained the same as earlier. Given that their lockup
should end shortly before they report first quarter results, I
would take that assessment with a mine full of salt.
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