Groupon Analysis

The IPO Analysis
By: Investors Mosaic
www.investorsmosaic.com
October 2011

© Investors’ Mosaic, Inc.

The Thesis


Don’t Buy the IPO, a Better Risk/Reward
Opportunity Will Present Itself
• Groupon is a viable business, but there are too many unknowns
about the business model to invest at such an extreme valuation
• The company has grown so fast it likely lacks proper human and IT
infrastructure, and is vulnerable to severe growing pains
• The management team is thin for such a large and complex
business model (currently no CTO, CIO, or COO)
• Company may have to hit the pause button on growth to
strengthen itself for long-term success = valuation compression
• Investors will face multiple rounds of stock sales in the medium
and long-term as only 5% of stock being offered
• Management has “cashed out” hundreds of millions from previous
financings, so incentives may not align with shareholders

Recent Metrics Are Concerning as Growth Has
Slowed, Creating Questions Around Their Ability to
Grow Profitably

Takeaway: In an effort to minimize operating losses, Groupon has slowed spending on
marketing and hiring of sales people. This has caused a significant slowdown in
sequential growth and calls into question the scalability of the business.
© Investors’ Mosaic, Inc. www.investorsmosaic.com

Key Metrics Point to Slowing Growth


Growth Slowing as Groupon “Dresses Up” for
the IPO; What Happens Next?

Takeaway: The million-dollar question is whether or not this is the pause that refreshes,
or an indication that the business has gotten out over it’s skis.


Key Financial Metrics
• Featured Merchants – this is the core of the business; without satisfied
merchants, the business is not sustainable
• Groupons Sold – shows that people like what they are offering
• Average Revenue per Groupon – indicates relevance of deal
• % of Gross Billings Retained – indicates perceived value of service and
the level of competition
• Repeat Customers – indicates customers satisfaction
• Subscribers – Provides a list of customers for Groupon to “mine”

Note: Subscribers is a misleading statistic! This has no indication of the quality of the
lead. Merchant’s will ultimately care about getting “good” customers in the door, not
just anybody.


Bright spots Exist for the Business

• Groupon is the most recognized daily
deal site
• Incremental profitability has improved
lately (but at the cost of growth?)
• Revenue per Groupon on the rise
• Some very smart Venture Capital firms
are involved (Accel Partners, DST, KPCB)


There are Several Questions Regarding the
Business Model That Need Answered Before
We Can Confidently Recommend the Stock
• Do Groupons provide an attractive ROI for merchant’s?
– Unclear if deals are generally profitable or create repeat customers
• Merchants are beginning to place limitations on Groupon deals
– Merchants are becoming more savvy, which will limit revenue for Groupon
• Merchants may be unaware of the legal risk they are assuming
– How will merchants respond to this risk when / if gift card laws become a
more prominent concern among regulators and lawmakers?
• Competition likely drive down margins
– Recent quarters demonstrates that Groupon taking smaller cuts of deal
• Not clear if network effects exist
– Larger merchant pool and subscriber base not driving scale in the business
• Groupons only work for merchants that have high frequency customer
visits, not long-term purchases like eye glasses
– How big is the pool of interested merchants once the hype wears off?


There are Several Questions Concerning the
Business Model That Need Answered Before
We can Confidently Recommend the Stock
• Very manual business model due to need for huge sales force to
reach widely distributed merchants; unlikely to experience
economies of scale predicted by management.
– The recent quarter implies that lower spending = lower growth
– Unlikely to achieve 25% - 35% operating margin predicted by mgmt
• Reports indicate that 25% of Groupon redeemers are loyal
customers, eating into profitable repeat business.
– Merchants need to figure out how to optimize Groupon offers in order
to make it a sustainable marketing offering
• A Rice University Study in September 2010 showed that:
– Groupon’s were profitable for 66%, not profitable for 32%
– 42% of the merchants would not run another Groupon deal


There Are Several Red Flags That Give Us
Pause as Investors
• Groupon had to re-file their IPO prospectus twice because of accounting
irregularities, indicating neglect or incompetence.
– Cut revenue by 50% because they reported all gross billings as revenue although Groupon
never had claim to this cash stream
– Removed adj. consolidated segment operating income from S-1 because the SEC felt it was
an inaccurate representation of on-going expenses

• Two Chief Operating Officers have left over the past six months, and the CTO
left in March. Groupon has yet to find a replacements.
– Could suggest complete lack of infrastructure at the company
– Something must be wrong for these people to leave right before the “big” IPO. Suspicious.

• The company is only selling 5% of shares outstanding, which should be viewed
as a gimmick to get a one-day pop.
– VC’s and employees are not cashing out on this deal, suggesting there will be substantial
stock coming on the market when the lock-up expires, or new secondaries are filed.
– Despite the small % offering, the absolute number of shares is huge (30 million) when
compared to LinkedIn’s 8 million offering.


There Are Several Red Flags That Give Us
Pause as Investors
• Two classes of shares – management will own only 0.4% of shares, but control
35% of the voting power.
– Most of this voting power resides with CEO Mason and Chairman Lefkofsky

• A company is still an infant – only 3 years old – and lacks proper infrastructure
that will need to be addressed soon, and likely to be painful.
– They’ve only had a CFO for 10 months
– No COO, CTO, or CIO
– Over the past three years, Groupon has hired 9.5 people per day on average!
It’s extremely unlikely that the company could have done this without cutting
corners and hiring undesirable employees

• Groupon risks legal action for not properly following abandoned property laws
related to unclaimed gift cards, and attempts to place all the risk on the
merchants.


Explosive Growth Has Left Several Gaps in the
Company’s Management Infrastructure
Groupon LivingSocial
• Groupon has vacancies in key
CEO Andrew Mason Tim O'Shaughnessy
CIO None Val Aleksenko managerial positions that prevent
CTO None Aaron Batalion the company from establishing a
CFO Jason Child John Bax
COO None Eric Eichman
long-term direction and laying the
General Counnsel David Schellhase Jim Bramson foundation for sustainable growth.
VP, Sales Darren Schwartz Mandy Cole
VP, Product Jeffery Holden Ian Costello
VP, Corporate Development Jason Harinstein Jake Maas
VP, Human Resources Brian Schipper Jennifer Trzepacz
VP, Engineering & Operations Brian Totty None
VP, Marketing Aaron Cooper Camille Watson

• Hard to believe that such Groupon
can maintain customer service levels
after such a massive hiring binge.
Shake out likely, and during the road
show, the CEO mentioned that
they’ll be firing the bottom 10% to
improve service levels.

The Business Model is Not Showing Meaningful
Signs of Economies of Scale to Justify Valuation

• M

It’s Hard to Tell if Groupon’s Negative
Working Capital Position is Sustainable
• Groupon collects cash from the
subscriber before they pay the
merchants, creating an
attractive cash “float” to fund
the business.
• However, if growth slows or
declines, a cash squeeze is
possible as incoming payables
will not offset liabilities.
• As of 3Q 2011, Groupon owes
merchants $465M.
• We cannot determine if this is a
long-term sustainable profile,
so we need to analyze a few
more quarterly reports before
making an assessment.


Investors Mosaic Survey Suggest the Daily Deal
Business is Viable, but Still Needs to be Fine-Tuned


LivingSocial Has Taken the Slower Growth
Path, Which May be More Sustainable
• LivingSocial appears to be building a better, more sustainable business
that is focused on building a higher-quality list of subscribers.
• What does Amazon know that we don’t? They can provide massive
distribution for LivingSocial via the Kindle platform.

Groupon LivingSocial
Markets 175 174
Countries in Operation 45 25
Subscribers (in millions) 143 46
Employees 10,418 3,900

Markets per Country 3.9 7.0
Subscribers per Market (millions) 0.8 0.3
Subscribers per Country (millions) 3.2 1.8
Cumulative Deals Purchased (millions) 30 22 Suggests that LivingSocial
as % of subscribers 21% 48% has more relevant deals
for their subscribers
Subscribers per Employee 13,726 11,795
Cumulative Deals per Employee 2,880 5,641

Financials


Key Metrics History www.investorsmosaic.com

Key Metrics 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11
Gross Billings 44,383 91,424 194,272 415,269 668,174 929,249 1,157,210
Revenue 20,272 38,666 81,779 172,224 295,523 392,582 430,161
Gross Billings Per Sales Person 347 71 124 161 188 192 238
Revenue Per Sales Person 158 30 52 67 83 81 89

New Subscribers 1,627,332 7,010,911 10,924,087 29,214,197 32,516,201 32,617,293 27,148,537
Subscribers 3,434,610 10,445,521 21,369,608 50,583,805 83,100,006 115,717,299 142,865,836
Featured Merchants 2,903 9,565 18,722 35,099 56,781 78,466 78,649
Groupons Sold 1,760,398 4,062,458 8,237,733 16,235,481 28,094,743 32,525,739 33,009,042
Groupons Sold per Featured Merchants 606 425 440 463 495 415 420

Avg. Rev. per Subscriber $ 7.70 $ 5.60 $ 5.10 $ 4.80 $ 4.40 $ 3.90 $ 3.30
Avg. Rev. per Groupon Sold $ 11.50 $ 9.50 $ 9.90 $ 10.60 $ 10.50 $ 12.10 $ 13.00

New Repeat Customers 258,344 636,299 1,129,825 2,297,185 3,711,436 3,871,264 3,978,857
Cumulative Repeat Customers 420,667 1,056,966 2,186,791 4,483,976 8,195,412 12,066,676 16,045,533
Cumulative Customers 16,000,000 23,000,000 30,000,000
% of total subscribers 19% 20% 21%

New Markets 13 20 22 69 21 - -
Total Markets 43 63 85 154 175 175 175

Sales Force
North America 128 201 348 493 661 990 1,004
International - 1,080 1,224 2,080 2,895 3,860 3,849
Total 128 1,281 1,572 2,573 3,556 4,850 4,853

Sales people hired per day 0.6 12.8 3.2 11.1 10.9 14.4 0.0
Revenue as % of Gross Billings 46% 42% 42% 41% 44% 42% 37%

Key Metrics History

Income Statement 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11
Revenue 20,272 38,666 81,779 172,224 295,523 392,582 430,161
Income (Loss) from Operations 8,571 (36,819) (55,967) (336,129) (117,148) (101,027) (239)
Net Income (Loss) Attributable to Groupon 8,511 (35,929) (49,032) (313,230) (102,668) (101,240) (10,573)

Adjustments
Stock-Based Compensation 116 3,960 4,663 27,429 18,864 38,718 3,340
Acquisition-related Expenses - 9,434 28,410 165,339 - - (4,793)
Total Adjustments 116 13,394 33,073 192,768 18,864 38,718 (1,453)

CSOI
North America 8,687 (378) 3,160 (21,905) (21,778) (10,501) 18,836
International - (23,047) (26,054) (121,456) (76,506) (51,808) (20,528)
Total CSOI 8,687 (23,425) (22,894) (143,361) (98,284) (62,309) (1,692)

As % of Sales
CSOI 42.9% -60.6% -28.0% -83.2% -33.3% -15.9% -0.4%
TTM 23.1% -21.4% -26.1% -57.8% -49.0% -34.7% -23.7%

Incremental Revenue 11,020 18,394 43,113 90,445 123,299 97,059 37,579
Incremental CSOI (Loss) 10,249 (32,112) 531 (120,467) 45,077 35,975 60,617
Incremental Operating Margin 93% -175% 1% -133% 37% 37% 161%
Incremental Operating Margin (TTM) -63% -31% -87% -39% -11% 6%


Balance Sheet & CASH FLOW STATEMENT
Net Loss (27,439)
2Q 2011
(223,667) (77,783)
3Q 2011
(238,083)
D&A 1,886 15,696 6,908 22,754
Cash Flow Statement Stock-based Compensation 4,076 57,582 8,739 60,922
BALANCE SHEET 2Q 2011 3Q 2011 Deferred Income Taxes (929) (2,237) (4,615) 602
Cash & Equivalents 225,093 243,935 Excess Tax Benefit - (3,532) - (11,323)
Accounts Receivable 99,674 109,852 Losses in Equity Interests - 8,763 - 19,974
Prepaid Expenses & Other 50,947 111,856 Non-Cash Interest Expense 72 - 106 -
Total Current Assets - 375,714 - 465,643 Acquisition-related Expense 9,434 - 37,844 (4,793)
Gain on Return of Common Stock - - - (4,916)
P&E, net 36,532 41,374
Goodwill 162,796 169,152 Working Capital
Intangible Assets, net 39,516 50,141 Accounts Receivable (3,477) (53,072) (16,071) (69,690)
Investments in Equity Interests 1,256 45,194 Prepaid Expenses & Other 2,818 (17,221) 1,916 (41,023)
Deferred Income Taxes 14,119 13,361 Accounts Payable 4,702 (14,374) 12,178 (21,924)
Other Non-Current Assets 7,779 10,702
Accrued Merchant Payable 18,726 216,870 47,518 314,872
Total Assets - 637,712 - 795,567
Accrued Expenses & Other 3,084 74,756 23,690 108,963
Due to Related Parties 3,555 46 682 361
Accounts Payable 49,033 40,345
Accrued Merchant Payable 391,894 465,586 Other (980) (1,626) (6,146) (7,185)
Accrued Expenses 164,700 156,552 Net Cash From Operations 15,528 57,984 34,966 129,511
Due to Related Parties 264 260
Deferred Income Taxes 13,058 12,597 PP&E (3,934) (21,202) (6,092) (29,825)
Other Current Liabilities 61,669 91,353 Acquisitions, net of cash 5,603 (3,696) 6,495 (12,553)
Total Current Liabilities - 680,618 - 766,693 Purchase of Intangible Assets - (272) (707) (15,072)
Changes in Restricted Cash 200 (1,025) 200 (8,141)
Deferred Income Taxes 2,180 4,788 Purchase of Investments in Subsidiaries - (34,387) - (34,887)
Other Non-Current Liabilities 23,533 39,719 Purchase of Equity in Investments - (9,921) - (20,189)
Total Liabilities - 706,331 - 811,200
Net Cash in Investing 1,869 (70,503) (104) (120,667)
Other 681 2,198 Issuance of Stock 134,932 509,692 134,932 509,692
Other Equity 9 9
Excess Tax Benefit - 3,532 - 11,323
Treasury Stock (808,448) (808,666)
Loans from Related Parties 1,647 - 5,035 -
Additional Paid-In Capital 1,352,133 1,422,351
Stockholder Receivable (180) (7,965) Repayments of Loans to Related Parties - (14,358) - (14,358)
Accumulated Deficit (623,376) (633,949) Preferred Stock Distributions - - - -
Accumulated Other Income 13,443 13,524 Repurchase of Common Stock (119,891) (353,550) (119,891) (353,550)
Total Groupon, Inc. Equity - (66,419) - (14,696) Proceeds from Exercise of Stock Options 37 1,234 68 2,269
Proceeds from Sales of Common Stock - 137 - 137
Non-Controlling Interests (2,881) (3,135) Dividends Paid - - - -
Total Equity (Deficit) - (69,300) - (17,831)
Redemption of Preferred Stock - (35,003) - (35,221)
Total Liabilities & Equity - 637,712 - 795,567
Net Cash From Financing 16,725 111,684 20,144 120,292
check o.k. o.k. o.k. o.k.
Effect of Foreign Exchange (516) 7,095 1,316 (4,034)
Working Capital (304,904) - (301,050) Change in Cash 33,606 106,260 56,322 125,102
as % of sales -44% -27%
Cash at Beginning 12,313 118,833 12,313 118,833
Merchant Payable as % of Sales 57% 42% Cash at End 45,919 225,093 68,635 243,935

Base Case Financials
Base Case Financials
2010 2011 2012 2013 2014
Revenue 312,941 1,554,464 1,941,123 2,223,809 2,408,066
Operating Income (180,993) (157,923) 92,122 183,741 247,126
Tax Rate 35% 35% 35% 35% 35%
Net Income (117,645) (102,650) 59,879 119,432 160,632

Shares Outstanding 637 637 669 703 738
EPS $ (0.18) $ (0.16) $ 0.09 $ 0.17 $ 0.22

Revenue growth yoy 397% 25% 15% 8%
Operating Income Growth nm nm 99% 34%
Operating Margin -10.2% 4.7% 8.3% 10.3%
Net Margin -6.6% 3.1% 5.4% 6.7%

Key Metrics 2010 2011 2012 2013 2014
Gross Billings 745,348 3,966,294 5,546,067 6,540,614 7,082,547
Revenue 312,941 1,554,464 1,941,123 2,223,809 2,408,066
Gross Billings Per Sales Person
Revenue Per Sales Person

New Subscribers 48,776,527 99,425,323 32,327,905 15,030,435 16,269,427
Subscribers 50,583,805 150,009,128 182,337,032 197,367,468 213,636,895
Featured Merchants 66,289 288,613 283,923 298,406 323,004
Groupons Sold 30,296,070 124,988,114 120,962,027 125,873,571 130,984,542
Groupons Sold per Featured Merchants 457 433 426 422 406

Avg. Rev. per Subscriber $ 6.19 $ 15.50 $ 11.68 $ 11.71 $ 11.72
Avg. Rev. per Groupon Sold $ 10.33 $ 12.44 $ 16.05 $ 17.67 $ 18.38

Valuation


Fundraising History Has Benefited Early
Investors, not the Business

• Previous investors have milked the hype,
VC funding bubble, and over-inflated
revenue metrics to cash out $956 million.
• The CEO’s incentives may be skewed since
he has already collected $31M; will he be
overly aggressive to hit a homerun?
• Now Groupon is asking for ~$500M for
general corporate purposes &acquisitions.
• Are you anxious to give them your money?

Valuation at the Last Round was a Bubble, so
You Should Be Careful About Paying Much More
• In December 2010 and January 2011, Groupon raised $942M from unusual
investors such as Fidelity Investments, T. Rowe Price, and The Growth Fund of
America. These are traditional mutual funds investing far outside of their
typical mandate. This is the definition of a bubble.
• During this round, the common stock was valued at $7.90. Also, investors also
likely used over-inflated revenue to justify their valuation. Yikes.

Groupon Valuation @ Mid Point
Proposed Share Price $ 17.00
Shares Outstanding 637
Market Cap ($BN) $ 10,834

2012 Revenue 1,941
Price / Sales 5.6x

2012 EPS $ 0.09
P/E 2012 190.0x


Valuation Comparisons
Valuation Worksheet
($ in 000's)

Enterprise Price / Price / 12 Revenue Price / TTM Gross EBITDA Operating
Market Cap Value 2011 Sales 2012 Sales Growth EBITDA Margin Margin Margin ROIC

Google 187,140 153,150 6.4x 5.2x 22% 11.4x 64.5% 45.9% 35.4% 20.7%
Amazon 90,000 88,000 1.8x 1.4x 33% 48.1x 22.0% 3.7% 4.1% 17.7%
Salesforce 17,560 17,910 7.9x 6.3x 25% 155.7x 80.5% 5.2% 5.9% 4.0%
Red Hat 9,270 8,020 8.2x 7.1x 15% 35.5x 83.5% 20.0% 16.0% 8.9%
LinkedIn 8,360 8,520 16.5x 10.9x 52% 177.9x 73.5% 9.4% 8.1% 7.3%
Tibco 4,440 4,150 4.9x 4.4x 11% 21.5x 71.6% 21.2% 16.5% 9.3%
Pandora 2,290 2,330 8.4x 5.5x 52% nm 91.6% nm nm nm
Zillow 779 729 12.6x 8.4x 50% 578.3x 66.4% 2.0% nm nm
Homeaway 2,720 2,600 12.0x 9.5x 26% 77.2x 78.8% 14.8% 8.7% 4.6%
Average 8.7x 6.5x 32% 138.2x 70.3% 15.3% 13.5% 10.3%
• As of 10/28/2011.
• Sources: Yahoo Finance and Market Watch

• The “right” valuation for Groupon will become more clear as the margin profile of the
business unfolds. If the company achieves 25% - 35% operating margin as
management predicts, this business is worth 5x – 6x sales. If the company is closer to
Amazon’s high-volume, low-margin business, the business is worth ~2x sales.


Valuation is Very Sensitive to Revenue Growth as
the Company will be Valued on Price/Sales. The
“Base Case” of $10.32 is our Fair Value Estimate.
Base Case (15% discount rate) 2011 2012 2013 2014 Investors Mosaic’s
Revenue Multiple 4.5x 4.5x 4.5x 4.5x Fair Value Estimate
Implied Market Cap 6,995,088 8,735,055 10,007,139 10,836,297
Shares Outstanding (in millions) 637 669 703 738
Per Share $ 10.98 $ 13.05 $ 14.24 $ 14.69
NPV $ 10.98 $ 11.35 $ 10.77 $ 9.66 Average $ 10.32

Upside Case (15% discount rate) 2011 2012 2013 2014
Revenue Multiple 6.5x 6.5x 6.5x 6.5x
Per Share $ 15.85 $ 18.86 $ 20.57 $ 21.22
NPV $ 15.85 $ 16.40 $ 15.56 $ 13.95 Average $ 14.90

Downside Case (15% discount rate) 2011 2012 2013 2014
Revenue Multiple 3.0x 3.0x 3.0x 3.0x
Per Share $ 7.32 $ 8.70 $ 9.49 $ 9.79
NPV $ 7.32 $ 7.57 $ 7.18 $ 6.44 Average $ 6.88

Takeaways
• The Daily Deal industry is viable, but it’s competitive landscape
and long-term profitability is unclear
• Groupon is a legitimate business, but several unanswered
questions surround the company and it’s business model and
cash flow generation capabilities
• Because of these uncertainties, it’s unwise to invest at such a
lofty valuation
• Groupon may need to shrink in the short-term to solidify it’s
human and technology infrastructure for long-term growth
• Near-term growth trends have slowed meaningfully as the
company “dresses up” the financials for the IPO
• Valuation will be tied revenue (price to sales)
• Pass on the IPO and wait for a better entry point

Appendices


Executive Departures Are Cause for Concern
Due to the Complexity of the Business Model

• Robert Solomon, former COO, leaves Groupon after only one
year to return to silicon valley.
• Groupon hires Margo Georgiadis as new COO on April 21, 2011.
She is a former Google executive – VP of Global Sales Operations.
– In late September, Margo Georgiadis leaves Groupon to return to Google
after only 5 months on the job. (Her employment agreement was to pay
her $500k /year salary with 100% bonus potential).
• Ken Pellitier, former CTO, left on March 23, 2010. Only one day
after Robert Solomon departed.

Takeaway: Such high-level departures, especially in such short order, do not reflect well
on upper management. Furthermore, why are these people so eager to leave so close
to a “mega” IPO? Suspicious…

Other Information


Key Metrics Groupon is not Providing

• Email open rates
• Employee turn-over


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