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Summary:

The jump in Groupon’s offering price for its IPO, and the first day’s trading in the stock, says a lot more about the current bubble-style investment climate and an overheated stock market than it does about the potential value of the group-buying company.

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After a wave of reports that Groupon would have to drop the price on its initial public offering or even cancel it altogether because of skepticism about the company and its business model, the pendulum of optimism swung back again by Friday and the shares listed at $20 — well above the range Groupon was originally planning — and jumped as high as $30 when they first opened. So what happened? Did Groupon’s business suddenly improve? No, it’s still as questionable as ever. What happened says a lot more about the current bubble-style investment climate and an overheated market than it does about the potential value of the group-buying company.

In a practical sense, what caused the stock to be priced higher than the original range — and to jump when it was first listed — was a simple case of supply and demand. Even though there continue to be widespread concerns about the company’s viability, which we have written about a number of times at GigaOM, analysts say there was a huge amount of interest in the stock from institutional investors, in part because there has been a long-term shortage of high-profile stock offerings in the technology sector until very recently when LinkedIn went public.

Huge demand and a tiny float of public stock

That and the kind of double-digit revenue growth Groupon has been generating — despite its conspicuous lack of profitability and high costs — created such massive demand for the shares (including reports that the issue was oversubscribed by 10 times) that they were almost guaranteed to move up. The second factor creating this mini-bubble for Groupon was the tiny amount of stock the company offered: just 4.7 percent of the total outstanding shares were floated in the IPO, which is the smallest public float for any newly traded company in more than a decade (LinkedIn issued almost twice as much, at 8.6 percent, and Google issued 7.2 percent of its stock).

In an interview on Bloomberg television before the issue started trading, financial analyst Paul Kedrosky called the process “transparently cynical” and a “public-relations exercise” more than anything else, and said the IPO price tells investors very little about the actual value of the company. A clip from the interview is embedded below:

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Although the IPO has brought in more than $700 million for Groupon — and made Co-Founder and CEO Andrew Mason a paper billionaire thanks to his stake in the company — it doesn’t change any of the fundamental issues that have made many analysts and investors skeptical about Groupon’s long-term viability. Among other things, the $700 million the company just got by going public is still less than the estimated $900 million or so that insiders and early investors (including management and directors of the company) pocketed for themselves after a financing round earlier this year.

Concerns remain about the viability of the model

Some observers believe this effectively forced the company to go public whether it wanted to or not, because it has such massive cash demands. Since it has to win over new customers in order to keep its email coupon business growing, Groupon spends hundreds of millions of dollars on marketing — and as a result has been losing tens of millions of dollars, and functioning at what amounts to negative cash flow.

Mason says the company will be able to reduce those marketing costs to virtually nothing over time while continuing to generate revenue from the customers on its email lists, but there’s a substantial amount of skepticism about whether that’s true. The company has been adding new products such as Groupon Now and a Groupon travel offering, to try to boost the amount of money it makes from each user, but results from markets in which it has been operating for some time seem to show that the value of a user drops off fairly dramatically the longer they’ve been a Groupon member.

In its “roadshow” presentation to potential investors before the IPO, Mason and other senior executives of the company argued that Groupon is similar to Amazon, which was also criticized for spending heavily and not being profitable and now has a market value of $98 billion. But many analysts are skeptical of this comparison as well, because Groupon’s model involves far higher marketing costs and generates what appears to be a much lower profit margin on every sale. Unless the company can boost the value of those sales by adding other things (which some have argued that it can) or reduce its costs dramatically, it doesn’t look like a business that has long-term growth prospects.

If you want to come to your own conclusions about the value of Groupon’s business, the roadshow presentation is embedded below:

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Post and thumbnail photos courtesy of Flickr users Thing Three and Groupon

  1. Yeah, maybe there’s a bubble, but it is a much smaller one in scope than past bubbles, just a relative handful of dot-coms, as opposed to all dot-coms.

    And don’t be so sure that people who wanted to buy Groupon stock believe it will become a profitable company. Profits, and growth in profits, often have nothing to do with the stock price, especially in an IPO. Many people are just betting that there will be lots of people who want to buy the stock, not betting that the company will grow or be profitable. And with such a small float, that’s not a terrible short-term bet to make.

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    1. Thanks, Ken. I agree this is not the same as the previous bubble (at least not yet) but the attitude you’re describing is still a bubble mentality nevertheless.

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      1. Not to mention, where is money supposed to go? Derivatives, money market, gov debt, housing, gold? Little incentive for most of that so money heads for a pure stock market play. It’s gonna happen, cause it’s gonna happen.

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  2. No, Groupon is popular, the way Netflix is popular, and that kind of popularity inflates a stock. Thank God we have Groupon and Netflix to complain about now, remember Coke vs. Pepsi?

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  3. For there to be a bubble the general public (economy) would actually have to be affected or at least notice if it popped. No one cares if a bunch of rich guys want to bet big on the flavor of the month. Besides a handful of tiny tech companies there’s massive underinvestment across the entire global economy. There’s nothing to pop. Thank goodness at least some people are spending on something.

    Is Groupon a good investment? Depends on your definition.

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  4. enough already! this/you is starting to get boring. Time to move on!

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  5. I agree. Groupon is not an example of a bubble. It’s actually an excellent example of the “Greater Fool” theory in practice. This should be painfully fun to watch as it plays out. I’m not a big google fan, but they dodged a $6 bullet!

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  6. This is not very different from whats happenibg with Faceboo, on the low float part.

    “Because a miniscule piece of Facebook got traded on SecondMarket, overall Facebook valuation at billions doesn’t make any sense”. – Is that a correct argument?

    We have some points here:
    http://statspotting.com/2011/03/the-truth-about-facebooks-valuation-numbers/

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  7. I don’t understand the investors who are buying the stock. I hope my pension fund hasn’t bought into this stock

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