UPDATE: 08-30-11 -- GROUPON EXPLAINS IT ALL IN AN EMPLOYEE MEMO
As reported in AllThingsD.com …
<excerpt from a memo by Andrew Mason, Groupon Groupon CEO and co-founder>
1. GROWTH IN THE CORE BUSINESS
Thanks to a tremendous effort by our sales team, August in the U.S. is shaping up to be a pivotal month. It appears that will revenues grow by about 12% over last month (which is a lot), while we cut our marketing expenses by 20% in the same period.
Beyond their obvious goodness, these numbers are important because they answer one of the main criticisms thrown at us in the past few months, relating to a metric we put in the S-1 called ACSOI (adjusted consolidated segment operating income) to help people understand how we think about marketing expenses. The reason everyone in the world seems to hate ACSOI is that it makes us look magically profitable by subtracting a bunch of our customer acquisition marketing costs from our expenses. The reason we didn’t realize everyone in the world would hate ACSOI (no, it’s not the same reason we didn’t realize everyone in the world would hate our Superbowl ad), is that we think it actually does a pretty good job at describing our marketing expenses in a steady state –we just didn’t realize there would be so many skeptics. I think it’s worth going deep on this one more time — brace yourself.
Our internal forecast shows two different types of marketing: what I’ll call “normal marketing” — which is NOT excluded from ACSOI — and “customer acquisition marketing,” which is. The way Groupon spends on marketing is unique in three ways:
1. We are currently spending more than just about any company ever on marketing — in Q2, we spent nearly 20% of our net revenue on marketing, while a typical company spends less than 5%. Why do we spend so much? The simple answer is “because it works.” But that’s only part of what makes our situation special.
2. Our marketing — at least the customer acquisition marketing that we remove from ACSOI — is designed to add people to our own long-term marketing channel — our daily email list. Once we have a customer’s email, we can continually market to them at no additional cost. Compare this to Johnson and Johnson, McDonald’s, or most other companies. If I’m a Johnson, and I’m trying to sell you a box of Band Aids, I have to keep spending money on commercials and magazine ads and stuff to remind you about how sweet Band Aids are, even after you’ve bought your first box. With Groupon, we just spend money one time to get you on our email list, and then every day we email you a reminder of the sweetness of our metaphorical Band Aid. There is no cost of reacquisition — that’s unusual (and we created ACSOI to point that out). If Johnson wanted to follow the Groupon strategy, he would have to start a free daily newspaper about bandages and then run Band Aid ads in it every day.
3. Eventually, we’ll ramp down marketing just as fast as we ramped it up, reducing the customer acquisition part of our marketing expenses (the piece that we remove in ACSOI) to nominal levels. We are spending a ton now because we’re acquiring as many subscribers as we can as quickly as we can. We aren’t paying attention to marketing budget (just marketing ROI) in the way a normal company would, because we know that even if we wanted to continue to spend at these levels, we would eventually run out of new subscribers to acquire. So our customer acquisition spend drops severely to reflect the fact that eventually we’ll run out of people we can add to our email list. We view this internally as a very large one-time expense and then our job forever after will be to continually convert these subscribers into customers and to make sure our customers keep buying from us. Ongoing, the normal marketing dollars we spend are not something we would remove from our internal calculation of ACSOI.
I tried my best to explain this simply, but it’s not lost on me that if you actually understood this, you probably had to read it three times. It’s not easy stuff. It’s much easier to assume that we’re goons. So people can be forgiven for being suspicious. In fact, feel a little bad about how downhearted the critics will be when we don’t turn out to be a Ponzi scheme — those are good impulses for journalists to have, and I hope our non-evil ways don’t destroy their spirits.
Anyway, there’s a reason that I just went on about ACSOI. One of the questions that skeptics ask is, “when you ramp down marketing, won’t revenues stop growing as well? Aren’t you just buying growth?” Over the past several months we’ve been consistently reducing our marketing spend and yet revenues are still increasing at a significant pace. In Q1 of this year, marketing represented 32.3% of our net revenues. By the end of Q2 it had fallen to 19.4%. And it has continued to fall over the past several months all because we’ve been investing in our own long-term marketing channel — our email list. <Read the full memo in context here.>
UPDATE: 08-10-11 -- GROUPON QUITS PLAYING "GAMES" WITH 'ACSOI" ACCOUNTING
"Groupon Inc., the biggest provider of online coupons, backed away from a controversial accounting method in an amended initial public offering filing today and reported a second-quarter loss. Groupon’s updated filing didn’t include figures for adjusted consolidated segment operating income, or adjusted CSOI, the financial metric it used previously. The company’s operating income accounting was being studied by the U.S. Securities and Exchange Commission as part of a routine review of its IPO registration, a person familiar with the matter said on July 27."
"Based on new accounting using CSOI, Groupon said it had a loss of $181 million last year, compared with adjusted CSOI of $60.6 million in a filing last month."
UPDATE: 07-19-11 -- ANOTHER IPO, ANOTHER EXAMPLE?
"Zillow priced its initial public offering on Tuesday at a higher-than-anticipated $20 a share, as the real estate Web site became the latest beneficiary of investor hunger for Internet companies."
"The company raised more than $69.2 million from the sale, valuing it at up to $550 million if its underwriters exercise an overallotment option. Zillow had previously expected to price its offering at $16 to $18 a share, having raised that range from $12 to $14 a share."
"Last year, Zillow reported $140,000 in adjusted profit atop $30.5 million in revenue. On a generally accepted accounting principles basis, the company lost nearly $6.8 million."
Just make sure you are not left holding the bag when things go south.
Original Blog Post ...
It’s all about valuation, the company’s value now and potential value some time in the future …
“Valuation: The process of determining the current worth of an asset or company. There are many techniques that can be used to determine value, some are subjective and others are objective.” <Source>
Most company valuation methods are based the valuation of its physical assets, intellectual property and on some multiple of its income.
Problematical when you lease almost everything, have intangible intellectual property rights in complex software, key personnel who can walk out the door and have produced nothing by net losses for the company’s entire future.
How do you get to a “multi-billion dollar” valuation?
So when you can’t sell the company to the public on a solid estimate of its value, the Wall Street Wizards sell it based on a story – a legal fiction that purports to illustrate the potential value inherent in the company – even though a rational man would see nothing that can support a multi-billion dollar”valuation.
Especially when there are other, more well-established players on the Internet, that can easily adopt your business model.
Enter ACSOI …
ACSOI -- the acronym standing for Adjusted Consolidated Segment Operating Income.
In Groupon’s S-1 Security Registration Statement filed with the Securities and Exchange Commission, we find the following statement:
We don't measure ourselves in conventional ways.
There are three main financial metrics that we track closely.
First, we track gross profit, which we believe is the best proxy for the value we're creating.
Second, we measure free cash flow—there is no better metric for long-term financial stability.
Finally, we use a third metric to measure our financial performance—Adjusted Consolidated Segment Operating Income, or Adjusted CSOI. This metric is our consolidated segment operating income before our new subscriber acquisition costs and certain non-cash charges; we think of it as our operating profitability before marketing costs incurred for long-term growth.
Between the perception …
We measure our business with several financial metrics.
The key metrics are gross profit, adjusted consolidated segment operating income, or Adjusted CSOI, and free cash flow.
Adjusted CSOI and free cash flow are non-GAAP financial measures. [Generally Accepted Accounting Principles] See "—Summary Consolidated Financial and Other Data—Non-GAAP Financial Measures" for a reconciliation of these measures to the most applicable financial measures under GAAP.
We believe gross profit is an important indicator for our business because it is a reflection of the value of our service to our merchants. In 2010 and the first quarter of 2011, we generated gross profit of $280.0 million and $270.0 million, respectively.
We believe Adjusted CSOI is an important measure of the performance of our business as it excludes expenses that are non-cash or otherwise not indicative of future operating expenses. In 2010 and the first quarter of 2011, we generated Adjusted CSOI of $60.6 million and $81.6 million, respectively.
We believe free cash flow is an important indicator for our business because it measures the amount of cash we generate after spending on marketing, wages and benefits, capital expenditures and other items. Free cash flow also reflects changes in working capital. In 2010 and the first quarter of 2011, we generated free cash flow of $72.2 million and $7.0 million, respectively. <Source:SEC>
And the reality …
Our business is subject to a number of risks of which you should be aware before making an investment decision. These risks are discussed more fully under the caption "Risk Factors," and include but are not limited to the following:
- we may not maintain the revenue growth that we have experienced since inception;
- we have experienced rapid growth over a short period in a new market we have created and we do not know whether this market will continue to develop or whether it can be maintained;
- we base our decisions regarding investments in subscriber acquisition on assumptions regarding our ability to generate future profits that may prove to be inaccurate;
- we have incurred net losses since inception and we expect our operating expenses to increase significantly in the foreseeable future;
- if we fail to retain our existing subscribers or acquire new subscribers, our revenue and business will be harmed;
- if we fail to retain existing merchants or add new merchants, our revenue and business will be harmed;
- our business is highly competitive and competition presents an ongoing threat to the success of our business;
- if we are unable to recover subscriber acquisition costs with revenue and gross profit generated from those subscribers, our business and operating results will be harmed;
- if we are unable to maintain favorable terms with our merchants, our gross profit may be adversely affected; and
- our operating cash flow and results of operations could be adversely impacted if we change our merchant payment terms or our revenue does not continue to grow. <Source:SEC>
The weasel words …
Non-GAAP Financial Measures
We use adjusted consolidated segment operating income, or Adjusted CSOI, and free cash flow as key non-GAAP financial measures. Adjusted CSOI and free cash flow are used in addition to and in conjunction with results presented in accordance with GAAP and should not be relied upon to the exclusion of GAAP financial measures.
Adjusted CSOI is operating income of our two segments, North America and International, adjusted for online marketing expense, acquisition-related costs and stock-based compensation expense. Online marketing expense primarily represents the cost to acquire new subscribers and is dictated by the amount of growth we wish to pursue. Acquisition-related costs are non-recurring non-cash items related to certain of our acquisitions. Stock-based compensation expense is a non-cash item. We consider Adjusted CSOI to be an important measure of the performance of our business as it excludes expenses that are non-cash or otherwise not indicative of future operating expenses. We believe it is important to view Adjusted CSOI as a complement to our entire consolidated statements of operations.
Our use of Adjusted CSOI has limitations as an analytical tool, and you should not consider this measure in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
- Adjusted CSOI does not reflect the significant cash investments that we currently are making to acquire new subscribers;
- Adjusted CSOI does not reflect the potentially dilutive impact of issuing equity-based compensation to our management team and employees or in connection with acquisitions;
- Adjusted CSOI does not reflect any interest expense or the cash requirements necessary to service interest or principal payments on any indebtedness that we may incur;
- Adjusted CSOI does not reflect any foreign exchange gains and losses;
- Adjusted CSOI does not reflect any tax payments that we might make, which would represent a reduction in cash available to us;
- Adjusted CSOI does not reflect changes in, or cash requirements for, our working capital needs; and
- other companies, including companies in our industry, may calculate Adjusted CSOI differently or may use other financial measures to evaluate their profitability, which reduces the usefulness of it as a comparative measure.
Because of these limitations, Adjusted CSOI should not be considered as a measure of discretionary cash available to us to invest in the growth of our business. When evaluating our performance, you should consider Adjusted CSOI alongside other financial performance measures, including various cash flow metrics, net loss and our other GAAP results.
Free cash flow, which is reconciled to "Net cash (used in) provided by operating activities," is cash flow from operations reduced by "Purchases of property and equipment." We use free cash flow, and ratios based on it, to conduct and evaluate our business because, although it is similar to cash flow from operations, we believe it typically will present a more conservative measure of cash flows as purchases of fixed assets, software developed for internal use and website development costs are a necessary component of ongoing operations.
Free cash flow has limitations due to the fact that it does not represent the residual cash flow available for discretionary expenditures. For example, free cash flow does not include the cash payments for business acquisitions. In addition, free cash flow reflects the impact of the timing difference between when we are paid by customers and when we pay merchants. Therefore, we believe it is important to view free cash flow as a complement to our entire consolidated statements of cash flows.
How much would their valuation be?
If one were to believe published reports, the results of their initial public offering (IPO) would see the company valued between $2 billion and $20 billion dollars.
According to Reuters …
“Groupon filed to sell shares to the public last week, saying it hoped to raise at least $750 million. The document disclosed surging sales, but also high marketing costs that have so far left the company losing money.”
“Despite being currently unprofitable, the IPO may value Groupon at $20 billion or more.”
“Forrester's Mulpuru questioned that valuation on Wednesday, arguing that Groupon may be worth closer to $2 billion.”
"’There is no rational math that could possibly get anyone to the valuation Groupon thinks it deserves,’ the analyst wrote in an open letter to potential investors. ‘This IPO game isn't about finding value, it's about finding a greater fool who actually believes the valuation is true. Trust me, you will be the fool.’"
“A Groupon spokeswoman declined to comment on Mulpuru's letter.”
Bottom line …
We are not expressing an opinion on the company, its valuation or its accounting methods, but use the above data to illustrate the diversity of thought in the accounting profession when preparing financials for companies with significant losses and that are being potentially valued in astronomical terms.
We are using this blog post to highlight the exit strategies of the major players who, having taken venture capital, are attempting to convert real dollar losses into real dollar financial gains by taking a company public using nothing more than a plausible story.
We are also asking ourselves if this type of valuation is reminiscent of the recent dot com bubble bust when any company associated with the Internet was given an astronomical valuation even though they reported nothing but losses and faced significant competition.
We should also remember that it is the accounting profession that was complicit (an unindicted co-conspirator, so to speak) in the past and current financial crises. And it was the accounting profession who unnecessarily complicates financials and who gave us “Enron-style” accounting with its off-balance-sheet Special Purpose Entities, Special Purpose Vehicles to hide the truth in the footnotes -- and then helped to accelerate the velocity of the downward market spiral with their mark-to-market procedures.
And finally, we are recommending that you take the Better Business Bureau’s long-standing mantra to heart: “Investigate BEFORE you invest.”
“Nullius in verba.”-- take nobody's word for it!
“Beware of false knowledge; it is more dangerous than ignorance.”-- George Bernard Shaw
“Progressive, liberal, Socialist, Marxist, Democratic Socialist -- they are all COMMUNISTS.”
“The key to fighting the craziness of the progressives is to hold them responsible for their actions, not their intentions.” – OCS "The object in life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane." -- Marcus Aurelius “A people that elect corrupt politicians, imposters, thieves, and traitors are not victims... but accomplices” -- George Orwell
“The key to fighting the craziness of the progressives is to hold them responsible for their actions, not their intentions.” – OCS
"The object in life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane." -- Marcus Aurelius
“A people that elect corrupt politicians, imposters, thieves, and traitors are not victims... but accomplices” -- George Orwell