It’s been over six months since the Grumpies’ last Groupon commentary. Remember the financial restatements, revenue corrections , SEC criticism of the Company’s non-GAAP performance metrics, the internal control weaknesses over financial reporting, and public critiques of reported operating cash flows? Well, quite honestly, many of us had just tired of the Company’s story, until recently that is. But two events during the past month, Andrew Mason’s “resignation” and the Company’s 2012 10-K securities filing, made it impossible for me to remain silent any longer. As the marketing slogan suggests, Groupon is simply “the gift that keeps on giving.”
First, there’s Mr. Mason’s so-called “resignation” letter. Let’s be clear here…according to Groupon’s Form 8-K filed on February 28th, “Andrew D. Mason was terminated as Chief Executive Officer.” Unbelievable are those that actually praised Mr. Mason’s letter. But what really troubles me is that at least one person found his memo to employees “geeky, hilarious, and touching,” and another titled it a “charming goodbye letter.” I think more appropriate descriptors might be immature and irresponsible. Why am I being so grumpy about this? Let’s not forget that the Company incurred a $9 billion loss in value (a decline from a $12.7 billion IPO valuation to an estimated $3 billion value on February 28th) during his tenure as CEO. Phrases like “ I’m OK with having failed at this part of the journey,” or “maybe I’ll figure out how to channel this experience into something productive” are simply not acceptable. And for those that applaud his wisdom about having the “courage to start with the customer,” what about the investors? How could Mr. Mason have forgotten about them in his letter? Those who invested $9 billion in his business education should be outraged! His company’s loss in market capitalization makes today’s college tuition look amazingly affordable, if not downright cheap. Okay, enough of Mr. Mason…let’s turn to Groupon’s most recently filed 10-K.
But the recently filed 2012 10-K reveals a major change that has profound implications for Groupon’s business model and processes:
Apparently, management finally realized that its original “daily deals” strategy just wasn’t creating much value or delivering on the differentiation dimension. So, now Groupon has decided to pursue a more Amazon-like approach. While a dubious strategic shift, it does makes sense given Jason Child’s (Chief Financial Officer) tenure with Amazon from 1999 to 2010 (2012 10-K, page 11). Also, don’t forget that Jeffrey Holden, Sr. Vice President of Product Management, also spent time at Amazon between 1997 and 2006 (2012 10-K, page 11). When a plan is not working, it is not uncommon for some managers to fall back on what they know best.
But before we get to the financials, let’s reflect on what the Company’s redirection means for performance measurement (i.e., the numbers). A new strategy means new processes, which in turn affect metrics and reported results. This means that traditional financial statement analysis (FSA) cannot be relied upon to provide its usual meaningful results. FSA’s ratio and trend analyses are founded on the assumption of stable relationships, so when a company is transforming itself, the usefulness of these tools is somewhat limited. Further complicating FSA is the Company’s decision to reclassify financial statement items from prior years (2012 10-K, page 69). Does Groupon bother to tell us where the changes are? Of course not. Nevertheless, here are a few grumpy observations.
My biggest concern is the Company’s continuing struggle with estimates (and judgment). Remember how the grumpies complained last August about Groupon’s “unusual” gain on an e-commerce transaction that created second quarter profitability (see Groupon: Still Accounting Challenged)? This was a gain driven solely by the Company’s own estimates of fair value, the reasonableness of which we questioned at the time. Well, guess what? We were right again! In the fourth quarter (literally at the eleventh hour), the Company revised its value estimate of its F-tuan investment downward by almost 40 percent resulting in a write-down of $50.6 million (2012 10-K, page 84). This turnabout almost completely reverses the pre-tax $56 million gain that Groupon reported in the second quarter of 2012.
And while I’m on the topic of estimates and valuation, let’s not forget intangibles. Goodwill just keeps on growing from 9.4 percent of assets in 2011 to 10.17 percent in 2012. With the Company’s new mission and related business models, one can’t help but wonder what the implications are for previously recorded goodwill, particularly since the Company couldn’t get F-tuan’s number right. And a change in strategic direction clearly must impact intangibles. In fact, cracks are beginning to appear in the goodwill numbers. International segment revenue actually declined 15.9 percent in the final quarter of 2012 (2012 10-K, page 38) raising questions about reported international goodwill amounts. More troubling is that liabilities exceed assets for the EMEA and LATAM reporting units, and that Groupon actually looked at possible impairment for these units this year (2012 10-K, page 53). Ultimately, the Company decided that no write-down was necessary, but you have been warned again. In fact, I suspect this year’s 10-K language may be signaling an impairment charge in the very near future.
And then there is the Company’s deferred tax asset (DTA) intangible. As you may recall, the Grumpies first sounded the alarm on this intangible almost one year ago exactly in “Groupon’s First 10-K: Looking Under the Hood.” Well, guess what? The Company is still reporting a loss because it FINALLY recorded an allowance for the DTAs which it likely will never (ever) be able to use. It’s the increase in the DTA allowance (and several other tax factors) that drove the Groupon’s effective tax rate to an astronomical 153.7 percent in 2012 (see 2012 10-K, pages 46, 54, 104, and 114). This is what we warned you would happen in our previous blog postings, and it has come to pass. This is just more evidence of the Company’s struggle to make reliable estimates. If I were the regulators, I would consider the Company’s F-tuan write-down, it’s delay in reserving for its DTAs, and its forthcoming goodwill impairment as evidence of a potential material weakness in controls over financial reporting as it relates to fair value estimation. Heads up SEC…you too E&Y!
No review of Groupon would be complete without a discussion of non-GAAP performance metrics, and the Company does not disappoint us again. Yes, Groupon still relies on non-GAAP metrics (2012 10-K, page 47), but there are changes. The Company has shed its infamous CSOI metric in favor of “operating income (loss) excluding stock-based compensation and acquisition-related expense (benefit), net.” What would the acronym for this mouthful be? OIESBCAEN? I think I liked CSOI better…nevertheless, it’s still a curious metric that inflates operating performance. And there’s more…last year, the gross billings metric was considered by the Company to be an “operating metric” (2011 10-K, page 41), while now it is reported as a financial metric (2012 10-K, page 31).
What’s the big deal? Gross billings is a total sales number that does not deduct the merchant’s share of transaction revenue. Thus, gross billings is not a valid financial performance indicator…for goodness sakes, it doesn’t even appear in the financial statements. Moreover, to report gross billings as a financial performance metric actually decreases financial reporting transparency! Why? Well, Groupon reports growth rates in gross billings of 35 percent and 434.7 percent for 2012 and 2011, respectively (2012 10-K, page 35). Yet gross profit (a “real” financial indicator) decreased from 83.9 percent in 2011 to 69.2 percent in 2012 (2012 10-K, page 41). Now, you tell me…which sounds better, huge growth rates in gross billings or declines in gross profit?
While I’m on the topic of performance, despite the declines in gross profit percentage, income from operations has turned positive for the first time primarily due to reduced marketing expenses. The dramatic reversals in marketing and selling, general, and administrative (SG&A) expenses may reflect the Company’s changing business model, but given Groupon’s past reporting issues, one wonders if some of this expense volatility is due to the aforementioned decision to reclassify financial statement items. Just a thought. And did you notice that the percentage of stock based compensation as a percent of operating expenses is increasing (2012 10-K, page 35)? Why are managers continuing to reward themselves so highly despite continued losses, diminishing growth, and stock price declines?
Could there possibly be anything else you ask? Well yes, there are a couple of lesser financial reporting issues that continue to irritate this grumpy old accountant. Operating cash flows (OCF) have declined in 2012 despite accounts receivable liquidations, and the decrease is largely due to diminishing contributions of merchant payable flows to reported OCF. We warned you about this in “Groupon’s First 10-K: Looking Under the Hood.”
And why isn’t inventory reported separately as a current asset on the balance sheet? Given the Company’s new retail strategy, the $40 million inventory amount reported in the notes (2012 10-K, page 89), and the existence of separate accounting policy note (2012 10-K, page 70), inventory has earned its own line item disclosure on the face of the balance sheet.
Then there is the Company’s segment disclosure. Groupon acknowledges having four reporting units: North America, Europe, Middle East and Africa (EMEA), Asia Pacific (APAC), and Latin America (LATAM) (2012 10-K, page 70). Yet, the Company only discloses two business segments, North America and International. Oh, Groupon is probably GAAP compliant here basing their reporting on the size of the individual reporting units. But why can’t the Company just report all four units, and why the need to deduct certain expenses in calculating segment operating income (see note (2) in 2012 10-K on page 106)? Is this the 2012 version of last year’s CSOI?
So, where does all of this leave us?
- The Company is operating without a permanent CEO.
- The Company has abandoned its old mission in favor of a new one.
- The Company is transitioning to an untested business model which raises serious balance sheet valuation questions, particularly given management’s recent estimation difficulties.
- The Company continues to struggle with providing consistent and reliable financial reports, its efforts now further complicated by its current state of flux.
This essay reflects the opinion of the author and not necessarily that of The American College, or Villanova University.