Simple analysis: Groupon spends a lot more than it takes in. But given the significant revenue and perception of Groupon as the market leader, there's another pressing question: Can any company find a way to make money in this business? Because daily deals aren't some new type of Internet business. They're an old form of media sale that uses the Internet but that doesn't offer the ability to leverage technology to drop expenses.
Look at the statement of operations from Groupon's S-1 filing with the SEC (click to enlarge):
For a moment, forget about the contorted accounting definitions Groupon uses to make the business look better to investors by ignoring major regular expenses like the huge marketing budget, as Edwards points out.
Notice the cost of revenue, which "primarily consists of the amounts paid to and accrued for our merchants associated with the sale of [deals]." Popular perception is that Groupon takes half of the money from deal purchases, with the other half going to the businesses that actually provide the deal. But apparently Groupon has done a lot of deep discounting, as it only keeps around 40 percent of the deal revenue (click to enlarge):
I use the term net revenue rather than gross profit (which Groupon uses) to underscore that Groupon's real revenue only starts after you deduct what merchants get. This is similar to the traffic acquisition costs that a company like Google (GOOG) pays for advertising that appears on partners' web sites. However, last quarter, Google reported its TAC as 25 percent of that ad revenue, not 60 percent or more.
The "net as %" line shows the percentage of revenue retained by Groupon. It clearly started off well in the first quarter of last year, but must have plummeted. This year started lower than last. With competition, the amount is likely to drop even further -- and given that Groupon is the segment leader, it probably means that everyone else in the daily deal space will face similar revenue limitations.
Edwards discussed how the marketing costs were high for the first quarter in 2011 and 2010. Look at their progression over time (click to enlarge):
For some perspective, Google's SG&A for last quarter was 28.7 percent of its gross profit (net revenue). Even Yahoo's (YHOO) SG&A last quarter only hit 46.1 percent -- far below Groupon's 66 percent. And SG&A typically includes marketing.
Daily deals are a variation on a coupon business, one in which you need salespeople on the ground going to local businesses to close deals. It's tough work (and if you have less experienced people, the result of such advertising sales is the high degree of discounting that is evident).
That gets us to the last issue: subscribers. Groupon had 83 million total subscribers at the end of last quarter. The total number of unique customers that purchased deals from 2009 through the end of last quarter was 15.8 million. That's a 19 percent conversion rate in what is basically a direct response business. It's phenomenal. The number might go climb some over time, but you couldn't rationally count on it doing so.
Looks like an Internet business... but it's not
Edwards sees the high costs as the price of growth. That is true, but with a twist. Additional revenue means constantly getting new subscribers and new businesses that will advertise. That gets us to the big problem. Everyone has assumed that Groupon is an Internet business. But it's not.
Groupon, and the constantly growing number of competitors, are businesses that use the Internet. Technology delivers the ads, but it doesn't allow them to leverage operational costs the way a typical Internet business can. Revenue growth means proportionately higher expenses.
The company still lost $114 million on $270 million of net sales. That's better than last year, but, good lord, how many deals will it have to move to actually get profitable? And how long before consumer and merchant fatigue sets in and creates a sales ceiling?