How Groupon's Improved Bottom Line Conceals Its Real Problems

Groupon's (GRPN) oft-restated accounting is unbelievably confusing, but here's one simple metric to keep your eye on if you're trying to figure out whether this is a legitimate business or a Ponzi scheme. Compare Groupon's revenues to the amount it owes in short-term payables and its regular operating expenses. A healthy company must make more in sales than it routinely owes. That gives you an idea of where Groupon is headed*:

Q3 2011 Revenue: $430.2 million
Accrued expenses and merchant payables: $622 million
Q2 2011 Revenue: $392.6 million Accrued expenses and merchant payables: $557 million
Q1 2011 Revenue: $295.5 million Accrued expenses and merchant payables: $421 million

Note that Groupon never earns more revenue than its short-term accounts payable -- the money it owes in 60 days to its merchants and other suppliers. This puts Groupon's reporting of a net loss of $10.6 million for the third quarter in perspective. The tiny net loss looks good -- the company is nearly profitable following CEO Andrew Mason's vow to cut marketing costs -- but it's not going to be good enough in the long term.

In the short-term, Groupon hopes to make up for its cash shortfalls by selling $11.4 billion of stock in an IPO. It is selling only a tiny minority of its stock in that sale -- suggesting that management believes it may need to go back to the trough of the equity markets again and again before it is finally able to stand on its own two feet.

Push will come to shove if Groupon ever sees a period of revenue decline. The company is dependent for its day-to-day operating cash on receiving credit-card transactions immediately from subscribers and then delaying payment of the share it must give to its merchants. It keeps the "float," in other words, much like the operator of a Ponzi scheme. That type of scheme, in which the company will always need a greater amount of "new" subscriber money coming in than the "old" payments it owes merchants, will quickly become unviable if Groupon ever experiences a period of revenue decline, when there is less "new" money coming in.

Lo and behold, the company's sales grew only 9.6 percent sequentially, after a year-on-year period of 426 percent growth. That ought to make Mason very, very nervous. No wonder he wants that IPO to take place on Nov. 4, before the end of the fourth quarter: He needs the cash now, just in case sequential revenue turns negative.

*Correction: This item originally included some erroneous numbers describing operating expenses. Apologies for the error.
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