Groupon Could Find IPO a Tough Sale

Groupon started its toughest sales pitch last month when the daily deals website launched a roadshow to persuade investors to buy shares in its IPO. Groupon is expected to sell 30 million shares for between $16 and $18 a share.

Even after scaling back the issue and cutting the company’s valuation in half, the IPO may struggle. Aside from recent regulatory and operational bumps, investors and analysts are troubled by Groupon’s business model.

The concept is simple and potentially lucrative: sell a coupon for a local business and take a cut of the proceeds for facilitating the deal. But the market has attracted hundreds of rivals, including such well-funded giants as Google and Amazon.com.

“My views have not changed, despite the reduced valuation. We still have significant long-term questions about their business model,” said Michael Cuggino, who helps manage about $15 billion at Permanent Portfolio Funds in San Francisco. “They will get a lot of very hard questions from investors focused on their business outlook and profit expectations.”

Cuggino said he would not be attending the road show and is “nowhere near” investing in Groupon.

Other investors said they were intrigued enough to attend the roadshow, but saw the IPO price as still on the high side.

Groupon plans to sell 30 million shares, or less than a 5% stake, at between $16 and $18 each, raising up to $540 million, according to a recent regulatory filing.

The midpoint would value Groupon at $10.8 billion, far less than the $20 billion initially expected, but still above the $6 billion that Google offered to pay for the company last year.

“Groupon is an impressive business, but it’s coming with a pretty rich price tag,” said Ryan Jacob, manager of the Jacob Internet Fund, who watched Groupon’s roadshow presentation online late last month.

“They’re still young enough that the price seems too high to us, even at the reduced level,” Jacob added. “There’s impressive growth potential but a lot of risks.”

Groupon’s roadshow comes at a time when Q3 IPOs had a dismal showing.

Only five VC-backed companies went public in third quarter, raising $442.9 million. This is down roughly 64% from the same time period in 2010 when 14 IPOs raised $1.2 billion, according to data from Thomson Reuters (publisher of VCJ) and the National Venture Capital Association.

In fact, Q3’s results are the worst three-month period for VC-backed offerings since Q4 of 2009, when four IPOs totaled $349.3 million. Four of the IPOs—Tudou.com, Zillow, Tangoe and Carbonite—were in the IT sector. Horizon Pharma, which raised $49.5 million in July, was the sole non-IT offering.

The largest IPO came from Todou, the Chinese online video operator, which raised $174 million in August.

When Groupon goes IPO, what impact will it have on the market?

David Berman, a technology and retail specialist at hedge fund firm Durban Capital, said he would attend the roadshow, but has reservations about the IPO.

“The big issue for me is competition. Are there barriers to entry?” Berman added. “The other question is repeat business. It’s one thing to buy a Groupon once and visit the merchant, but are customers coming back again and again?”

While the Chicago-based company’s revenue and sales staff have grown dramatically since its founding in Oct. 2008, it has never been profitable on a net basis. It made a narrower operating loss in the third quarter, after excluding stock-based compensation.

“There are a lot of beat up Internet stocks that are profitable. This one isn’t,” said a manager of a Bay Area tech-focused investment firm.

He said he would look at Groupon but didn’t feel like he had to own it: “A $20 billion valuation is completely ludicrous. Ten billion is still too much.”

Luisa Beltran, senior writer at VCJ online affiliate peHUB, contributed to this article.