April 3, 2012 3:40pm EST - Freshly IPO’d Groupon hit yet another stumbling block as the company announced late Friday that its fourth quarter revenue and earnings – which had already missed its own underwriters’ estimates - were even lower than what the Company had previously reported in February.
Additionally, Groupon’s auditor Ernst & Young issued a rare Sarbanes-Oxley required statement of “material deficiencies in internal accounting controls” which legally required Groupon's hiring of yet another accounting firm – this time KPMG – to attempt to repair the deficiencies. This move now effectively has KPMG auditing the auditors, as well as Groupon's accounting controls, creating a mess to put it mildly. At a minimum, Groupon’s CFO must be replaced immediately, as PrivCo CEO Sam Hamadeh told Bloomberg Television last night.
Since Groupon’s accounting restatements weren’t merely of the bookkeeping kind – say, where revenue is moved from one period to another – but involved real business deterioration in the form of massive increases in customer refunds, the restatement and related announcements justify serious concerns about newly public Groupon’s business model.
PrivCo had previously sounded the alarm on Groupon’s accounting and underlying business model. This was not Groupon’s first accounting foul. Indeed Groupon is a repeat offender many times over in its short history. Last year, Groupon was forced to make the largest pre-IPO accounting restatement in recent history with the SEC slashing over half of Groupon’s claimed $1.5 billion revenue for 2011, a stunning difference of some $800 million.
The latest refund debacle is related to Groupon’s entry into Groupon Goods and Groupon Getaways, which it touted in its IPO roadshow as being essential to its nosebleed valuation. Since its daily deals business was already beginning to show signs of serious slowdown, Groupon was effectively saying ‘value us not on our current business, but on how big we’ll get with Groupon Goods and Groupon Getaways (as well as Groupon Now).’
The reality is now clear: Groupon Getaways and Groupon Goods customers are vastly unsatisfied. Customers have been returning goods and disputing charges, and these entire legs of Groupon’s valuation have been pulled out from under the Company.
Groupon’s travails should serve as a clear warning of what happens when private companies go public prematurely, without a handle on their business model, accounting, and without a seasoned executive team with public company experience in place.
1. Lack of Internal Controls: Groupon’s auditing firm, Ernst & Young, took the extremely rare and serious step to actually declare a material weakness in the daily deal company’s internal accounting controls. Due to Groupon’s fast growth into new deal price points, rapid-fire acquisitions, and its founders’ apparent focus on raising funds to partially cash themselves out to the tune of $941 million pre-IPO, Groupon failed to adequately design, document, and execute the necessary features to accurately and timely report its financial results.
2. Highly Touted New Business Segments Flawed: The bigger story is not a simple accounting error. During its roadshow, Groupon cited the Groupon Getaways and high-end Groupon Goods divisions as the future of the Company. However, customers are receiving re-furbished goods, used goods, and poor quality products from merchants operating under this segment of Groupon offerings. As profit margins on goods such as electronics, TVs, and tablets are already slim, it was impossible for merchants to offer compelling prices without cutting corners. A steady flow of returns and unhappy customers has essentially swept Groupon’s growth platform out from under them.
3. Young Company Cutting Advertising Spend, Using Aggressive Accounting, and Otherwise Scrambling to Meet Public Market Estimates: Groupon is clearly scrambling to reach public market revenue and earnings estimates. As part of that, Groupon has been trying to “hard force” a slight profit by cutting the necessary marketing needed to lure new visitors to Groupon.com. Since cutting marketing spend, unique visitors to Groupon.com per month have fallen 57% from 33.7 million in June 2011 to 14.5 million in February 2012. The short-term oriented public markets are now dictating Groupon’s business decisions, something Groupon should instead be doing as a private company looking to maximize long term value.
4. Unprepared Management Team: Groupon’s accounting department has been one reporting disaster after another, casting serious doubts about its CFO, Jason Child, who is having his first ever stint as CFO of a public company. After large re-statements which more than halved Groupon’s 2011 revenue, the latest mistakes indicate a clear need for replacing the CFO as soon as possible. Even co-founder Eric Lefkofsky ran afoul of SEC “quiet period” regulations pre-IPO by telling the media Groupon would be ”wildly profitable”. The current managment team at Groupon is simply not yet prepared for regulatory scrutiny as a public company. Contrast Groupon with Facebook, which has installed CFO David Ebersman – former CFO of public company giant Genentech – and COO Sheryl Sandberg from Google – and has had a smooth IPO process by every measure.
5. Dangers of Dual Class Voting Stock: IPO investors must refuse to accept dual-class super-voting stock structures that leave all power in the hands of a couple of founders, and Groupon is a clear example why: the CFO clearly must go, yet the Board has no power to force the change unless the super-voting holders – co-founders Andrew Mason, Eric Lefkofsky, and Brad Keywell – all agree. And it is also fairly apparent that CEO Andrew Mason – formerly a music student before Groupon – is unprepared to be CEO of a public company with a $10 billion+ market cap. Investors deserve better, yet can’t force Mason to relinquish the CEO spot without his own permission. Dual-class super-voting stock structures are dangerous, and Groupon is a poster child of why that is the case.
The current crop of privately-held companies can learn a valuable lesson from the Groupon disaster that is occuring before our eyes in slow motion. Scale and massive growth in a short amount of time in and of themselves do not warrant an IPO. The private capital markets exist for a reason.