Groupon's IPO Prices at $20 Per Share

 

Groupon’s roadshow certainly had its highs and lows, but founder and CEO Andrew Mason expected skeptical audiences.  A roadshow consists of a series of meetings with potential investors and brokers conducted by a company and its underwriter prior to an initial public offering.  Normally a casual dresser, Mason got a new haircut and dressed in a suit as he attempted to persuade prospective financiers that Groupon is a sound investment choice.  At the end of Tuesday, Groupon priced its initial public offering at $20, exceeding the expected range of $16 to $18. 

Groupon is initially selling just 35 million shares, or 5 percent of total shares.  The low supply has caused an increase in the price.  In this regard, Groupon is following a trend set by other US internet firms.  LinkedIn, which went public in May, sold less than 10 percent of its total stock in its IPO. 
On November 4, Groupon will start trading on the NASDAQ stock exchange.  If the stock price increases significantly on the first day, expect Zynga and Facebook to expedite their IPOs. 

Groupon’s business model is somewhat questionable, causing uncertainty among potential investors.  The tech company prompts customers to shop as groups rather than individuals so they can earn deep discounts from local businesses.  The discounts only apply if there is a certain number of customers that sign up for a deal.  As explained on Groupon’s site, “Each day, Groupon e-mails its members one unbeatable offer on something great to do in your city.  We offer consumers great values by guaranteeing businesses a minimum number of customers.  If a certain number of people sign up, then everyone gets the Groupon offer.  If that minimum isn’t reached, then no one gets it.”

Groupon seizes economies of scale by connecting large numbers of customers with businesses.  A company captures economies of scale when it lowers the average cost per unit through increased production.  For instance, when 10,000 laptops are made, the per unit cost is cheaper than if only 1000 were manufactured because fixed costs are spread over a larger production batch.
Local businesses receive two benefits from Groupon’s offerings.  First, they receive guaranteed demand for their products and services, which lowers excess inventory and attains economies of scale.  Second, Groupon creates communication and anticipation for new products and services. 
On the positive side, Groupon has demonstrated rapid growth.  In under 2 years, it has grown from 152,203 subscribers to 83.1 million.  During that same time, revenue has grown from $3.3 million to $644.7 million.

So how does Groupon make money?  Consumers purchase a coupon through the Groupon website.  When someone purchases, say, a $40 massage, for $20, Groupon will keep $10 and pass the remaining $10 onto the business.  In this instance, the massage parlor is providing a $40 massage for $10, but it attracted a customer it might have otherwise not gained.
This business model might not be sustainable because small businesses are actually hurt when a Groupon is successful.  Potential losses increase with every Groupon customer that walks through the door.  Imagine if 10,000 people showed up wanting a $40 service, but the company only receives $10 per massage.  The massage parlor’s per unit revenue will be slashed by 75%, but its costs remain the same.      

Businesses with high fixed costs and low variable costs will benefit from using Groupon.  Health club memberships, yoga classes, sporting events, DVDs all fall under this category.  High margin businesses that can afford a 75% reduction in revenue might also be interested in Groupon.  Take for example a jewelry shop where the retail price is 500% of the actual cost.  A Groupon 75% discount (25% to Groupon, 50% to the customer) might work for this type of business. 

What do you think?  Is Groupon’s business model sustainable?  Is the $20 stock price too high?