The discount voucher giant is producing results after failing to live up to early expectations but will it ever satisfy investors?
When Groupon opened its offices in Korea, it hired 300 people in a week. That is no mean feat in a brand-new market, but the company simply pulled people in off the street.
“When people walked by, we’d bring them up to the office,” recalls Eric Lefkofsky, the company’s co-founder and chief executive.
Perhaps alarm bells should have rung that the company was growing too fast but then hindsight is always 20:20. At the time, says Lefkofsky, there was a sense of urgency. “It felt like we were in a land grab. It felt like, if we didn’t get set up and [have] people calling merchants, then someone else would.”
Groupon (NasdaqGS: GRPN - news) did not exist until November 2008, but by the time it was opening in Korea, two-and-a-half years later, it was operating in more than 40 countries. That same year, revenues soared from $700m (£424m) to $4bn. It was the fastest-growing company in the world and the world was knocking on its door.
It had already turned down a $6bn offer from Google (NasdaqGS: GOOG - news) . Then, when Groupon rejected the offer in favour of going public, Goldman Sachs (NYSE: GS-PB - news) chief executive Lloyd Blankfein flew to its Chicago base to ensure his bank secured the work on the initial public offering.
Andrew Mason, who co-founded the business with Lefkofsky, was feted as a visionary. Groupon used people’s collective bargaining power to secure discounts for things such as restaurant meals and manicures, and then sold those discounted services to people, one at a time. People imagined the model would change the way people did business forever.
The youthful Mason (Shenzhen: 002654.SZ - news) also represented a new kind of chief executive. He would crack jokes and created a tongue-in-cheek work environment where meeting rooms had silly names, like “I wish this was a bathroom” and “No diggity”.
But the laughs started sounding somewhat hollow as the business started to sour.
Groupon was valued at as much as $16.6bn shortly after it went public, but its market capitalisation dived as low as $1.7bn amid concerns about spiralling costs and its accounting measures. It didn’t exactly shore up confidence that the company had to restate its first set of accounts as a listed company after discovering a “material weakness” (refunds being demanded by customers were higher than expected).
In late February 2013, some 15 months after the company’s initial public offering, Mason was ousted. In his valedictory note to staff, he wrote: “I was fired today. If you’re wondering why . . . you haven’t been paying attention.”
He has since moved to San Francisco and released an album, Hardly Workin’, full of ballads about entrepreneurship. One of them has the lyric, “I was climbing Machu Picchu / As I beheld the splendid view / An idea came for 100 million / Of shareholder value.” It all seems rather surreal corporate America meets Monty Python.
Today, Groupon has reclaimed some of the ground it lost from its share price, and is valued at $5.6bn. More importantly, the company is intent on keeping a straight face and growing up.
At 43, Lefkofsky has a decade on his predecessor, and a long career of investing in companies through his private equity firm, Lightbank. He took two of them public before Groupon.
“I am a builder… when things have to get built that don’t exist, that’s what I’m good at,” he says.
The Detroit native, who gave the young Mason his first $1m in seed-funding, took the chief executive post on an interim basis that later became permanent. Just over a year in, he is bemused that people think he is rescuing the company from some kind of disaster. “People always say to me, 'How is the turnaround going?’, or 'You’re doing great. Looks (BSE: LOOKS.BO - news) like you guys have really turned it around,’ and I think to myself, 'Let’s see: we went from $5.3bn to $5.8bn in sales [in 2013]. And in that year we generated $287m of Ebitda [earnings before interest tax, depreciation and amortisation] and $157m of free cash flow, both of which were way up from the year before.
“Then I think of all these internet companies that are losing tons of money, that have no Ebitda, that burn cash like crazy, and I think it is funny that people perceive us as a turnaround.”
Groupon was arguably one of the biggest beneficiaries of dotcom hype, but that doesn’t stop Lefkofsky being flummoxed by the valuations put on companies such as Twitter (NYSE: TWTR - news) . The social network is trading at $23bn on annual revenues of $665m, despite the fact it has never turned a profit.
“Valuations are what they are, but at the present moment people are valuing growth at very high multiples, and they are willing to go very far out before they would get a return. When you are doing that, you have to be a very sophisticated investor, because there is inherent risk when you are valuing something at 20 times revenue, or 30 times, or 40 times.”
The problem Groupon faces is that although growth is still positive, it is nowhere close to the stratospheric levels of two years ago. Meanwhile, profits are bumpy, rattling investors’ faith that this will ever be the goldmine they hoped for. At its last results, Lefkofsky who famously promised that Groupon would be “wildly profitable” warned investors that it was on track to deliver between $20m and $40m in earnings in the current quarter, down from analysts’ forecasts of $96m.
He blamed the downgrade on the unexpectedly high cost of digesting recent acquisitions. (Groupon bought Korean deals business, Ticket Monster, for $250m, and has agreed to buy fashion discount site Ideeli for $43m.) In truth, however, the entire company has spent the past two years digesting the unexpectedly high cost of its own natural growth, as it built the necessary foundations retroactively.
At the same time, it has evolved considerably from its original concept of offering a single deal a day, via email, which acted as “the devil on your shoulder” tempting consumers to try something new. It still does that, but it is also trying to reinvent itself as the place people check whenever they want to buy goods, or use any local service almost like a directory, or search engine.
“You will check Groupon regularly no matter where you are in the world,” Lefkofsky says. “It’s raining, let me check Groupon because not only can I buy an umbrella, I can have it shipped to me at home in London, or I can pick it up down the street.’”
He points out that mobile usage the weak point of many internet companies is Groupon’s strength. Around half of all transactions are made through its app, which has been downloaded around 70m times. The company’s task now is to work out how to make “using a Groupon easier than not using a Groupon”.
To the many investors who got burned by the spectacular nosedive in Groupon’s value, this might read as though the company’s executives have had their heads in the sand for the past few years. But sat in their Chicago headquarters, Lefkofsky and his colleagues are remarkably candid about some of the horrors of the past. Over the course of a few hours, they remember vividly the “infamous day” of Mason’s departure and the gut-wrenching feeling of having to restate their accounts. They also roll their eyes at the bashing they received at the hands of the British press.
Groupon was excoriated after a cupcake seller was forced to bake through the night just to meet demand, and repeatedly slammed by the Advertising Standards Authority and the Office of Fair Trading for exaggerating claims about possible savings. The company claims it was given a rougher ride in Britain than anywhere else, but Jason Childs, Groupon’s chief financial officer, adds generously: “The UK keeps businesses honest in a better way than anyone else does.”
But despite all this, it is clear that the company’s leaders view the tumult as mere growing pains, and still regard Groupon as a robust business that promises to become a Goliath of the order of Amazon or Google. Mason used to compare Groupon to a “toddler in a grown man’s body”. Childs describes it as a “really gawky 13-year-old whose braces are about to come off”, compared to the “really good-looking 25-year-old” that is Amazon.
He is in a better position than most to make the comparison. Before joining Groupon, he spent 12 years at Amazon, including its early days when the internet retailer posted a loss every quarter, and investors questioned whether it could ever move beyond books and DVDs.
“The scars are permanently etched from that period. I can’t help but recall it on a daily basis, because the comparisons are so similar in terms of the [urgency to] get big fast, going out to land grab… then taking all the criticism on profitability,” he says. The question is whether Groupon can mimic Amazon’s later trajectory as closely as the retailer’s early years.
Ken Sena, an analyst at Evercore, is sceptical. “I think there will always be a need for a discounting platform, and Groupon fulfills that need pretty well, but at this moment I don’t see how it can provide search and navigational capabilities in a way that will replace [other services]. It’s a good comparison to look at Google versus Amazon, but Amazon’s philosophy is based on price, convenience and selection.”
Groupon has price sorted, and can work on the second, he says, but the deep discounts it requires from merchants means it will always struggle to provide customers with a comprehensive range of goods or services. “If you have a great product, you are not going to sell it at Groupon’s discounted rate.”
Lefkofsky argues that Groupon is trying to do a different thing from Amazon, but admits he also uses the Seattle internet behemoth as something of a yardstick.
“It has been very [instructive] to watch, how [Amazon founder Jeff] Bezos did not lose sight of being long-term focused. He was willing to suffer short-term pain to be long-term focused.”
But although both companies are trying to break new ground, Bezos was operating in a very different world from the one Lefkofsky has to deal with. Facebook (NasdaqGS: FB - news) did not exist. Blogging was a new phenomenon. Newspaper websites were perfunctory. Trading volumes were just over half of what they are today. Market sentiment for better or worse was much slower to spread.
“Being a public company chief executive in the year 2014 is not always an easy task, especially when you are building a high-growth tech company that aims to be disruptive,” Lefkofsky admits.
“It’s a tricky job. I don’t wish I wasn’t doing it, but everything has got faster for public companies. The media has got faster. Trading has got faster. The world has got faster. I sometimes wish that people would recognise that really amazing companies often take time to get built. People want you to deliver every quarter and they want you to be important years from now.”
The serial entrepreneur has a lot of skin in the game he owns a 15.8pc stake in the company, worth more than $904m at today’s valuation. At one point, his holding was worth almost $3bn, but he seems pretty relaxed that Groupon can “reaccelerate growth pretty dramatically” and get back to those levels.
“You just have to say to yourself, 'If I have a vision, if I know what I want to build, if every data point that I see tells me this is going to work, then I am just going to put my head down and keep building.’ Eventually, the markets will see it,” he says.
If and when investor sentiment shifts, he expects it to happen fast. “Markets move too fast for years. They think in terms of quarters. The market reappraises companies very quickly,” he says.
There are no barriers in place to Groupon’s success other than its own effectiveness, he adds. “The vision is ours to execute but it is ours to execute. So when you say, 'What’s the hurdle?’, it’s just that. It’s that these 13,000 people around the world have to march in a very orchestrated way to deliver upon that dream. It’s complicated. If it was easy to do, other people would have done it.”
Groupon has already won some battles. In the run-up to its initial public offering, analysts were deeply concerned about the low barriers to entry for other would-be players. If Andrew Mason in Chicago had pulled off this trick so spectacularly, what was to stop other companies following suit?
Lefkofsky chuckles. “You have to look at it and say, that was the single greatest myth ever propagated. Microsoft (Berlin: MSF.BE - news) launched a daily deal product, eBay, Amazon, Facebook, Google I can stop or I can keep going. At one point, everyone launched a near-perfectly similar Groupon clone, and [today] most of them are out of the business.
“People have come to realise that, 'Oh my god, there are immense barriers to entry to this.’ It is easy to put up a site, but we have 13,000 people. It is incredibly human-intensive, and once merchants get what they want somewhere, there is not a lot of reason to go elsewhere.
“For Google not to have dominance in search, someone would have to create [something] materially better. It’s the same with us, I think. We are the leaders in local commerce.”
However painful the journey may have been, Groupon’s dominance in the deals market owes a lot to its early hell-for-leather expansion.
Many investors might expect Lefkofsky to shake his head and try to blame all the errors on Mason, but he is surprisingly sanguine about the path Groupon has taken.
“In the first five years of a company’s history, you are still baking the cake. It would have been nice to have the luxury of being private longer,” he says, “but we felt we were in a situation where we were going to trip that 500 shareholder limitation anyway, and we didn’t have a ton of time.” (America’s Securities and Exchange Commission used to force companies to go public as soon as they had more than 500 shareholders. It has since raised that threshold to 2,500.)
“We grew very fast and we grew very fast internationally. Going public in the midst of all that created a lot of volatility . . . If I was looking at Groupon, I would think the same things you would think: 'Boy, they went public too soon and they created a lot of geography.’ We are number one in those markets [we entered early], and had we entered those markets later, someone else would be number one.”
He highlights Korea to illustrate his point. Groupon was relatively late to set up shop in Seoul, and never recovered its lost ground. It was forced to buy Ticket Monster from its rival, Living Social, to help it catch up.
“[The journey] has been bumpy at times, but we are in a good place now. If you said to me, 'You could go back in time and change things’, it wouldn’t be such a quick answer,” Lefkofsky muses. “Put another way, no clear regrets.”
For a man with so much of his personal wealth at stake, that is quite a statement. But then a man with so much of his personal wealth at stake has a vested interest in talking up the business.
Groupon may be in better shape now than a year ago, but from an investor standpoint it will still be some time before it is out of the woods.