Is Groupon (NASDAQ:GRPN) the next Enron? –No. It’s worse.
Before the company even went public, there were signs that internal financial controls weren’t up to snuff. Now I’m hearing refrains of “three blind mice” as “defrauded” investors line up to have their day in court. You might as well say the “dog ate my homework.”
It’s not like no one knew this was coming.
The U.S. Securities and Exchange Commission (SEC) made management redo Groupon’s financial statements and accounting practices not once, but twice before the company’s January 2011 initial public offering (IPO).
The first time involved including the cost of marketing in operating income – duh. The second was to force the company to deduct merchant payments from revenues – double duh!
Both are basic accounting principles.
If you spent $2 to gain $1 in orders you have to report that as a $1 loss if you’re dealing with cold, hard cash. Also, if you have $1 in merchant payments, you can’t count that as $2 in revenues, unless apparently you work at Groupon and love accrual accounting. It’s not like Groupon execs can claim they didn’t know.
It’s abundantly clear to me that the “company” has very little, if any, understanding of REG FD and securities litigation.
(REG FD, in case you are not familiar with it, is short for Regulation Fair Disclosure which the SEC adopted Aug. 15, 2000. REG FD is intended to eliminate selective disclosure of material non-public information.)
But I have a hunch they’re going to find out the hard way.
Groupon’s Material Weakness:
When the SEC came knocking again on April 2nd the company was forced to restate its Q4 financials. That summarily reduced Groupon’s revenue by $14 million and profits – assuming there were any to begin with – by $22.6 million. In an official statement, Ernst & Young, the company’s primary auditor, noted “material weakness” with regard to the company’s internal controls. Investors simply noted that they’d better get going while the going was good.
Any other company would be begging major networks for air time to explain themselves. Yet Groupon execs appear to be holed up in their Chicago headquarters either in blithe ignorance of the mess they created or in deliberate avoidance of the tough questions that they would have to answer.
Speaking of tough questions, Milberg, LLP has announced a class action lawsuit on behalf of purchasers of Groupon’s common stock between Nov. 4, 2011 and March 30, 2012. And Johnson & Weaver, LLP, a San Diego-based shareholder rights law firm has announced an investigation into breaches of fiduciary duty by Groupon officers and directors.
This is the legal equivalent of saying you screwed your shareholders, your underwriters and everybody else. Folded into this is the implication that the company lied its asteroids off.
No wonder The Wall Street Journal has reported that there is a growing chorus of cries to write down the company’s goodwill. And I’m not talking about the Webster’s definition of “hope and intention” either. I’m talking about the kind of accounting that formed the basis for the huge $166.9 million entry noted on Groupon’s 10-k as of December 31, 2011.
Goodwill, in case you are not familiar with that definition, includes things that cannot be easily valued but which are determined by accountants to add to the value of any business over and above its actual financial assets.
Groupon Price History
Here’s an example.
If you’ve got $10 million in stuff like equipment, buildings, and machinery and your company is valued at $100 million because you’ve got a cool brand, legions of hipster customers, and the Internet is hot, congratulate yourself. You’ve got $90 million in goodwill that can’t technically be valued but which is theoretically recognized by insiders, and investment bankers anxious to push up the value of an IPO.
As notes my good friend Ziad Abdelnour, President of Blackhawk Partners, Inc. in his book, Economic Warfare, “great wealth rarely comes from speculating and creating nothing.”
I agree – yet creating something from nothing describes virtually the entire social media space at the moment, which is why I have repeatedly and very vocally discouraged investors from “buying” in. Social media stocks are not investments; they are speculation in its purest form. If you’ve got the stomach for it and want to risk the money, fine.
After all, that’s your decision.
But don’t confuse the promise of real companies with real products, dividends and cash flow with the greater fool theory – as in some greater fool is going to come along and pay you more than you paid at an undetermined point in the future.
The vast majority of social media companies have terribly flawed business models.