As Groupon pursues its plans for an IPO, it’s proposed valuation keeps on going up. First it was $15 billion, now it’s $25 billion, according to a report by Bloomberg. Remember, it was only in January, 2011 that it closed a $950 million venture round at a valuation just shy of $5 billion.
What’s going on here? Is this yet one more sign of Internet valuations getting out of hand—dare I say the “B” word? One of Groupon’s venture investors, Ben Horowitz of Andreessen Horowitz, doesn’t think there is a bubble. At a press dinner last night in New York City, we were discussing valuations in general and he pointed out that Groupon is now doing “multiple billions of dollars in revenues.” To be fair, Horowitz was in a roomful of bloggers and journalists trying to pin him down on a number and he was hemming and hawing, but he seemed to be referring to expected 2011 revenues. I take “multiple billions” of dollars to mean more than $2 billion, which was the annualized run-rate back in December. Compare that number with the $760 million in revenues for 2010 reported by the WSJ and you get a sense of its growth. Remember also that Groupon is only two years old. The faster the growth rate, the higher the valuation.
But this isn’t only about valuation, it’s about ego. At $25 billion, a Groupon IPO would nudge Google to become the largest venture-backed IPO ever. Yup, the same Google which offered to buy Groupon for only $6 billion last December as well. And that sounded crazy. An IPO at $25 billion would be as much about taking Google’s mantle as anything else.
The key to the valuation is not so much revenues as it is profits, and right now Groupon seems to be wildly profitable, supporting the salaries of thousands of sales people and other employees, and expanding across the globe. The number thrown out yesterday was 5,000 employees. Groupon’s revenues are split with the local merchants who offer discounts through the service much like Google splits AdSense revenues with participating Websites. So the local merchants take at least 50 percent of the revenue off the top. What’s left is still an extremely high-margin business that has managed to bridge the divide between online and local commerce in a major way for the first time.
Local commerce is a huge chunk of the economy, and whoever brings those businesses online successfully could arguably be tapping into a market as big or bigger than online search advertising. At least that’s what Groupon’s prospective bankers will be saying when they try to convince investors to buy the IPO.
But there is a huge catch here. Nobody, not even Groupon, really knows how big it can become or how long it can sustain its 50 percent revenue split with merchants. If the size of the U.S. economy alone is $14.7 trillion, how much of that is local? I don’t know, but it’s enormous and any dent in bringing even the smallest fraction of those local businesses online in terms of advertising could mask problems in the underlying model for some time.
When a small business like a restaurant puts out a Groupon offer for 50 percent to 70 percent off a meal, it gets flooded with new customers, so much so that many businesses can’t deal with the foot traffic. But that is all just marketing dollars in the forms of discounted services. It’s lead generation for local businesses. But how many of those customers come back to pay full price? There is no good way of measuring that yet. And that is going to be the key to Groupon’s long-term valuation, whether or not it is creating repeat, loyal customers for merchants or just a stampede of deal-hungry coupon clippers.