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Déjà vu: 1999 

Have you ever been in a dream where you thought for sure it was real?What would happen if you couldn't awake from that dream? How would you know if it was real, or not? It's 1999, the Matrix - one of the most creative movies of the century - is released and the stock market has seen companies trading at 3 and 4 digit PEs soar with no business models and even less prospects for the future.

It's 2011, Groupon, LinkedIn, Facebook, Banks, Brokers & REITs are all partying like its 1999! Subscribers, feel free to download  Groupon Forensic Analysis & Valuation (923.04 kB 2011-06-16 10:34:36)

Social networking stocks are the current obsession for Wall Street bankers. Groupon, LinkedIn and Facebook - a trio of Internet darlings are dabbling the public markets and could even eclipse the market value of internet gaint Google. We have discussed in explicit detail, the valuations and realistic expectations of these companies in the recent past. As a refresher:

1. A Realistic Forensic Valuation of LinkedIn – There Ain’t No Surprises Here…
2. The Anatomy Of The Record Bonus Pool As The Foregone Conclusion: We Plug The Numbers From Goldman’s Facebook Fund Marketing Brochure Into Our Models
3. Did Goldman Just Rip Its HNW and Institutional Clients Once Again? Facebook Growth Slows Pre-IPO, Just As We Warned!

• There are also host of other internet startups including Pandora (a music streaming service), HomeAway (online vacation-rentals company) Zynga and PopCap (social gaming sites) that are planning to test their fortunes at Wall Street. After LinkedIn which debuted as one the most expensive IPO (yet one of the most successful) in the American history based on the ratio of its market value to its yearly sales, Groupon has filed its IPO filings to test the market appetite for internet start-ups. If the same frenzied marketers who created the frenzy of buyers who greeted LinkedIn on the first day of trading meet together on Groupon’s listing day, its market value could soon touch $50bn (assuming $25bn IPO). LinkedIn which debuted as the most expensive of IPOs has a current price-to-sales ratio of 28x. Facebook, reportedly to generate $2bn of sales, is commanding a valuation of $70bn in private markets with price-to-sales of 35x. Remember, these are the private markets, with a significant liquidity discount to account for the lack of access to public markets! Groupon with $1.3bn of sales (trailing 12 months) and IPO of $25bn valuation would be 19 times sales and 38 times if it gets as lucky as LinkedIn. These ratios are unmatched in the entire S&P Composite 1500 index of small, midsize and large companies. Indeed, investment bankers (Goldman Sachs and their friends at Morgan Stanley and elsewhere) have to be duly credited in their successful creation of abject euphoria surrounding tech companies. There’s a definitive dearth of commentary in the world of financial pundits regarding traditional metrics such as PE, which is admittedly not applicable to high growth tech start-ups since they fuel rapid growth in the early stages with strong reinvestment of earnings resulting in a dearth of earnings to show off. The caveat is that many observers fail to charge the expenditure of said cash flows with actual value creation. Is value actually being created with the reinvestment of earnings and cash flows or are would be earnings simply being used to purchase additional revenues?

The academic risk-reward trade off, among other things means, has traditionally meant that investors pay less for things that are unproven, ceteris paribus. At the moment, investors are paying premiums for unproven models. After LinkedIn, a similar yet dissimilar strategy is in place for Groupon, aiming for that perfect IPO. After all, you can’t fool someone with same strategy again, even if they may be captured investors that don’t subscribe to BoomBustBlog. If LinkedIn was all about pent up demand and social media with reliable earnings stream, then HYPER-growth is the new mantra at Groupon. Groupon has been credited as one of the fastest growing companies in history. No doubt, Groupon’s revenue grew at astronomical pace growing 2241% in 2010 and 1357% in Q1-2011. However, paying a premium for growth and premium for uncertain things are altogether different things. At the moment, investors are confusing a growth model with an unproven business model. Groupon, LinkedIn and Facebook (to an extent), although all in high growth stages, have yet to demonstrate a lasting and formidable business model and as yet should not command such premium valuation. Perhaps after giving all the discounts-of-the-day to its subscribers, the IPO is just a means to square up things at Groupon.

The Groupon Business Model

Is It Right To look To Groupon’s Sales As A Performance Metric?

Groupon’s revenue consists of the gross amount paid by customers for purchased Groupon while gross profit is the amount that the company retains after paying its merchants an agreed upon percentage of the purchase price to the featured merchant. So the comparable number for price-to-sales to use for Groupon is gross profit, or the fees it collects from merchants, which the management has correctly stated as the best proxy for the value created by the company. To put things into perspective, if eBay used the same math as Groupon does, it would have report revenues of $61bn instead of $9bn. The company reported gross profit of $530m over last 12 months. At $25bn valuation that would put the valuation at 42x “comparable sales”. To put things in perspective, Google trades at Price-to-sales of 5.8x, Apple at 4.7x, Microsoft at 3.3x, Amazon at 2.6x and Yahoo at 3.4x.

As excerpted from page 3 of the BoomBustBlog subscription document  Groupon Forensic Analysis & Valuation (923.04 kB 2011-06-16 10:34:36):

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