Is Groupon a Giant Ponzi Scheme?

The Groupon IPO hit the market last week, netting the company $700 Million in return for the public sale of 5.5% of the company's stock. The stock debuted at $20/share and climbed to $31 before closing at $28. Based on these numbers, Groupon is worth approximately $17 Billion. But is it? Amazingly, the IPO was a big success while there is still doubt as to whether Groupon has a business model that is even profitable. The company spends 50% of it's revenue on marketing and has yet to turn a profit.  Is Groupon a revolution in local commerce or a giant ponzi scheme?

I think it's both and here's why:

First, Groupon creates marginal value for merchants and for customers. Andrew Mason, Groupon's Founder and CEO says his company creates value by helping local businesses cheaply and easily attract new customers, and by helping Groupon customers find fun and discounted things to buy, eat, or experience in their cities. But in my view this "value" is marginal on both sides.

For merchants, Groupon brings lots of un-targeted customers who are unlikely to ever return (since they use Groupon to find deals, not whatever the merchant is selling). And for customers, Groupon gives them a wicked deal on....something....not necessarily something they would want at full price. For example, the fact that I can get super cheap fencing lessons doesn't mean that I want fencing lessons, and is unlikely to translate into me purchasing full-price fencing lessons in the future.

Even though Groupon seems to be papering over these problems with hundreds of millions of dollars of investor money, I still say the value proposition is dubious.

Secondly, I'm wondering if Groupon has a sustainable engine of growth? i.e. are they growing because local businesses and customers love the service, or because they are sinking hundreds of millions of dollars into advertizing to buy customers who use the service once and never come back?

That is: Will Groupon's customers be worth more than they cost to acquire (meaning Groupon will be sustainably profitable) or will they cost more to acquire than they are ultimately worth (meaning Groupon is a giant ponzi scheme and will be bankrupt soon). I think the answer is almost surely the latter simply because customer acquisition costs will go up as Groupon moves from early adopter customers to mainstream customers, and the lifetime value of each customer will fall as competing daily deal sites eat away at Groupon's margins.

So what the heck is going on? how is Groupon worth $17 Billion on yearly revenues of $1.3 Billion, an operating loss of $420 Million in 2010, and no sustainable way to be profitable or protect its market lead?

Here's my take: while Groupon seems to have invented a novel way to connect local businesses with customers, the founders and investors know that they are ultimately selling a commodity product with no intellectual property protection, no product differentiation, and no barriers to entry.  Worse, the daily deal business is not a natural monopoly business and therefore niche deal sites like DineOutCheap (which focuses on restaurant deals) and BizyDeal (which focusses on business deals) among hundreds of other sites can pick away Groupon's customers through specialization in each deal category.

So what to do if you take hundreds of millions of dollars in investor money and discover that your business is ultimately unsustainable? whip up some hype, and sell to the public markets! And the best way to do that is to grow as fast as possible, use vanity metrics to make it seem like the company is valuable, and cash out before it all starts to fall apart.

And this seems to be what is happening: Over the last year, Groupon has taken in nearly a billion dollars of investor money, and paid most of it out to the original founders and investors in cash. This is a gigantic red flag. Not to mention that the IPO allowed Groupon to narrowly escape bankrupcy.

I hope I'm wrong, but it seems like Groupon is ripe for implosion and the founders, investors and underwriting investment banks know it. Look for wicked deals on office furniture in Chicago in about 6 months.