The deal may be off for Groupon, analysts warn

? Brendan Mcdermid / Reuters / REUTERS

Groupon's shares debut on the Nasdaq Stock Market.

By Roland Jones

Groupon is offering a cut-price deal -- on its stock price.

Shares of the daily deals website have fallen some 17 percent over the past few days following reports of accounting errors at the daily deals website. Adding fuel to the fire was a report in The Wall Street Journal Tuesday that said the SEC is examining Groupon?s revision of its first set of financial results as a public company, which were released in February.

The regulator?s probe is at an early stage, the Journal said, but the newspaper noted that it follows two other revisions to Groupon?s finances made before its debut as a public company last fall.

These earnings problems are leading experts to question the reliability of the daily coupon site?s financial reporting, and even its long-term viability as a public company.

Groupon wowed investors when it went public in November -- the latest in a list of new social media companies to hit the public markets. Its share price rose above its IPO price of $20 per share to as high as $30 per share the first day of trading.

But it has since seen its share price sink 42 percent from those opening levels. It is currently trading near $15, but could go lower, according to Jordan Rohan, a senior analyst at Stifel Nicolaus. He said Groupon?s accounting problems may seem minor, but they are actually having a major effect on the outlook for the company.

?There are very few instances where a company?s growing pains are communicated to investors in a Friday night accounting revision,? he told CNBC Monday. ?It?s not just a below-the-line revision [that] doesn?t matter; it?s that they were seeing higher refunds being requested by consumers for whatever reason.?

Groupon makes money by sending e-mails to subscribers about potential deals at retailers that it offers at a discount. A $40 meal at a restaurant, for example, maybe offered at $20. Groupon makes money by keeping approximately half the money the customer pays for the coupon, so the $40 meal could be purchased by the consumer for $20, and the restaurant and Groupon would receive $10 each.

Groupon pays companies up front and gets paid back over period of a year or so.?The problem for Groupon is some of those companies are taking the money up front and then going out of business, leaving Groupon with the cost of paying a refund.

Refund activity at Groupon has risen as it has expanded into higher-priced deals, for more expensive restaurant meals or even Lasik eye surgery. While the move expands the potential market for Groupon deals, it also increases the cost of refunds.

Rohan raises the question of whether the company?s ?addressable market? is really as large as it thinks it is, adding that there may be more ?bumps in the road? ahead for the company.

?This is a business model where [the company] is making it up or proceeding along a plan as we are following them as a public company,? he said, adding that he is concerned ?that if the addressable market isn?t as big as they said it was we will find that out in an unglamorous fashion over the next few years.?

Rakesh Agrawal, principal analyst at reDesign mobile, thinks Groupon?s business model is fundamentally flawed. The difficulty for the company now is it must maintain growth to satisfy Wall Street investors, and so there may be more pain ahead for the company, he said.

?Groupon?s problem is similar to the subprime lending problem,? he said. ?Groupon is saying we will give a restaurant cash now, but it doesn?t have to deliver a product. The businesses that sign up for Groupon are desperate, and when they go out of business, Groupon has to pay a refund.?

Agrawal estimates that there are currently between $500 million and $750 million worth of outstanding Groupons.

?Like during the subprime mortgage crisis, there?s no way of tracking them,? he said.

?It?s as if Groupon is holding on to a portfolio of subprime loans,? Agrawal continued. ?It?s holding on to a pile of risk without knowing the height of the risk it has. The only good thing is, unlike the mortgage crisis, Groupon is not large enough to have any systemic effects on the economy.?

Agrawal says Groupon could see, in a worst case scenario, major credit card companies refuse to do business with it because they see potential liabilities for their businesses.

?The credit card companies may look at the pile of risk associated with Groupon and say they are not going to be associated with it,? Agrawal said. ?If they shut down the use of their payment mechanisms they could shut the company down tomorrow.?

A way for Groupon to revive its business would be to potentially partner with companies that have more stable business models, he added. They could use the cash raised in the November IPO to purchase these companies, he said.

Groupon could also devise a mechanism that removes the risk it faces -- primarily, refunds to Groupon customers -- and place it on the customer, or look more closely at the companies it does business with and refuse to do deals with ones that appear unsound, Agrawal suggested.

The difficulty for Groupon going forward is it faces competition from other coupon and deal providers, such as Living Social.

Agrawal says Living Social is in a better position than Groupon because?it?s not a public company, and so can play around with business models without the need to show strong growth to Wall Street investors. It also has a heavyweight backer with deep pockets: Amazon.com.

Groupon?s troubles are an example of how investors haven?t learned from the dot-com bubble, Agrawal said.

?Groupon investors were attracted to strong revenue growth at Groupon, but they didn?t learn that you can easily show rapid revenue growth by simply giving money away,? he said. ?Or in this case, by giving away money from small businesses.?

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