The last week or so has been downright tough on Groupon. The Wall Street Journal, many tech tweeters and tech bloggers have been unforgiving, suspicious of Groupon.
I read the reports, looked at the financials, considered the argument that Groupon applied a “fuzzy accounting” standard. As a businessman, I am certainly sensitive to any appearance of impropriety. I know that when a start-up becomes successful what was initially okayed by the CPA as Generally Acceptable Accounting Principles (GAAP) can suddenly become “fuzzy accounting.” I never intend to be in that position.
That being said, I actually accept Groupon’s accounting and financial system as reasonable and financially sound based on Groupon’s unusual business model.
The link is to Groupon’s S-1 statement filed with the SEC - http://sec.gov/Archives/edgar/data/1490281/000104746911005613/a2203913zs-1.htm
Critics have been suspicious because in 2010, Groupon generated revenues of $713 million and reported an operating loss of $420 million. However, in the same S-1, Groupon claims that it will make money in 2011 using a different measure of operating income. Groupon calls this “Adjusted CSOI.” Adjusted CSOI means “Consolidated Segment Operating Income.”
The Groupon critics claim that the term Adjusted CSOI carries two pieces of information that create what is being termed “fuzzy accounting”
(1) the word “adjusted” and
(2) a new acronym for earning.
I disagree that the accounting is fuzzy or deceptive in any manner whatsoever.
According to Groupon, “Adjusted CSOI” – income (before expensing to acquire new subscribers) is taken into account. According to the Groupon critics, since this expense amounted to about a third of overall operating expenses in 2010, removing it increased profitability significantly.
But the Groupon critics are forgetting the basics of accounting.
The argument for Groupon’s accounting system is that the enormous cost of acquiring new customers creates benefits over many years. And, once a customer is acquired, he or she continues to use Groupon for years. The acquisition costs are capital expenses and should not be netted out to arrive at the operating income. Acquisition costs should always be capitalized. In the case of Groupon, the acquisition costs just happen to be those associated with acquiring the customers. Unusual? Perhaps. But it is not so unusual that we should dismiss the argument summarily.
Consider reclassifying acquisition costs from a valuation perspective. For growing companies like Groupon, reclassifying acquisition costs can make the earnings look positive. However, reclassifying acquisition costs will also increase the capital invested at the growing companies (because the acquisition costs will be capitalized).
The reclassification of acquisition costs can arguably change perspectives on whether the growing company is actually profitable and creating value. But that is not, in my opinion, an issue in this case because the Groupon business model is unique. In the long run, the key profitability number is the return on invested capital – not the operating margin. And, Groupon admits that it invests a significant amount of capital in what it spends to acquire customers. That decision is appropriate especially and so long as the customers are repeat and/or long-term.
Groupon’s recent interface with the ShopSavvy application provides assurance that Groupon’s customers’ will indeed be repeat and/or long term. ShopSavvy benefits Groupon and Groupon’s customer base by sending coupons focused to person, preferences, location. ShopSavvy provides greater likelihood that customers will continue to use Groupon.
In the words of Mark Twain, Groupon: “the report of [our] death is exaggerated.”