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Daily deals site Groupon is launching its IPO roadshow this week and is seeking a $10 billion valuation for the company, less than half of what was rumored when the company first filed to go public in June. That’s a big haircut.

With the recent turmoil in the markets, it’s a terrible time to bring a new offering to market. But Groupon may have no choice: based on the numbers we’ve seen from the company to date, it’s burning through cash and may have to go public in order keep the lights on.

According to the company’s latest S-1 filing, its merchant liabilities have increased 19% from $392 to $467 million in the last quarter. Its current liabilities exceed its current assets by more than $300 million.

Groupon uses money from new deals to pay off merchants from previous deals, so Groupon’s continued existence is dependent on consumers and merchants having confidence in Groupon’s continued existence.

In recent weeks, Groupon has experienced a barrage of negative publicity from a wide range of media outlets, including The New York Times. Neither Reuters nor The Associated Press had a positive quote from analysts in their coverage of the company.

If consumers believe that Groupon deals might not be honored and stop buying them, the company will be starved for cash and will collapse.

If merchants believe that they might not be paid for Groupons that they issue and stop running Groupons, the company will be starved for cash and will collapse.

If markets were perfectly efficient, Groupon would collapse overnight like Lehman Brothers.

Groupon bears a lot of similarity to the subprime mortgage crisis:

  • No one knows how much value is out there in outstanding Groupons. No one has kept track. Groupon is working to improve this, but many Groupons are still tracked by pen and paper or not tracked at all.
  • Groupon issues big checks to merchants without any credit check or due diligence. Groupon is taking on a lot of risk of merchants not honoring their obligations. See my earlier VentureBeat story on the challenges that relying on small businesses poses for Groupon.
  • It’s impossible to tell with certainty who will owe money to whom if Groupon fails.
  • Banks don’t fully understand the risk they are taking on.
  • Groupon merchants don’t fully understand the service that they are buying. Groupon is pitched to merchants as a “no risk” way of reaching consumers. There may be no money down, but running a Groupon has a lot of long-term risk, including losing money on poorly targeted customers and damaging your Yelp ratings.
  • Much like housing market models that relied on housing prices to continue to grow, Groupon’s model relies on continued revenue growth. With the latest S-1, we saw that once Groupon slows investment in marketing, revenue growth slows down substantially.

Here’s my best analysis of who stands to lose if Groupon collapses:

Consumers. Groupon purchasers could lose between $500 million and $1 billion. This depends on two major factors: the extent to which merchants choose to honor Groupons and the ability to dispute charges with credit card companies.

Recommendation: Consumers should only purchase Groupons they can use within 60 days. Avoid Groupons for big ticket purchases (like travel) far into the future.

Small businesses. Merchants who sell products and services through Groupon stand to lose up to $500 million. In the United States and Canada, merchants are typically paid within 60 days of the date the Groupon runs. In the rest of the world, merchants are typically paid after the Groupon is redeemed. The big question is what merchants choose to do in the case of a Groupon failure. Do they continue to honor Groupons that were issued? Or do they tell consumers, “Sorry, not our problem?” Continuing to honor Groupons would be the right customer service move but bad for profits. This will vary by merchant.

Recommendation: While I’ve long advised most categories of small businesses to avoid running Groupons just based on the terrible economics, I believe businesses should consider Groupon credit risk. If the cash from running Groupons is critical to your business, I would recommend against running them.

Credit card companies. These are potential losers that may surprise a lot of people. Companies such as Chase Paymentech and American Express could also lose hundreds of millions. The companies essentially serve as a backstop for consumers.

According to Visa’s Ted Carr, for 60 days after the statement on which a charge appears, “Visa operating regulations provide card issuers and cardholders with protection when a merchant ceases operations and the cardholder does not receive what was paid for (the merchant’s bank/acquirer is liable.)”

American Express’s Marina Hoffmann Norville said it’s possible that consumers would be able to dispute charges for longer than 60 days. “We will determine on a case-by-case basis how we will address disputes in those instances where a merchant goes bankrupt or abruptly ceases operation,” she said.

Other credit card issuers like Citi and Bank of America may also lose if they choose to issue refunds in the name of good customer service and can’t recover the money from Groupon’s merchant bank.

With new products like Groupon Getaways, this risk gets even bigger. Instead of a $40 transaction, many transactions are in the hundreds of dollars.

The risk is magnified by the fact that there are often no clear records of Groupon redemptions. Unscrupulous consumers may seek refunds even after they’ve used a Groupon.

Recommendation: Credit card companies are in a tough spot. They can increase the holdback that they have for Groupon. This means that they would hold back more money to cover potential losses. But this would hurt Groupon’s cash flow; that in itself could cause Groupon to collapse. Frontier Airlines was forced into bankruptcy when its credit card processor, First Data, decided to hold back more of the proceeds from ticket sales.

Business partners. Groupon spends hundreds of millions on advertising, much of it on the Internet. Ad networks and publishers stand to lose any unpaid money.

Recommendation: Companies who are heavily dependent on Groupon advertising revenue should look closely at the risk exposure that they have and consider whether the payment terms they give to Groupon are appropriate. This is especially true for ad networks that pay out to publishers in advance of receiving payment.

City of Chicago. Chicago has built its tech reputation on Groupon’s meteoric rise. In many ways, this has been undeserved because Groupon is fundamentally a sales and marketing company, not a technology company. (Fewer than 5% of Groupon’s employees are in technology; many of those are based in Palo Alto.) Some Chicagoans are worried about the impact a Groupon collapse will have on the psyche and reputation of the city.

Rick Summer, a senior equity analyst for Morningstar, a Chicago-based investment research firm, says, “I’m pretty neutral on Groupon’s importance to the city. But I take the longer-term prudent view of’ ‘freeing up good people to run better business.'”

Employees. Groupon employs more than 10,000 people. They stand to lose their jobs and any unpaid wages.

Investors. Of course, public and private investors stand to lose their entire investment. Summer’s analysis values Groupon at $5 billion, less than half the value that the company is seeking. That’s also less than the reported $6 billion that Google offered for Groupon. In Morningstar’s research report, he writes, “IPO investors face a nontrivial risk of permanent capital impairment.” That’s a fancy way of saying IPO investors stand to lose their shirts.

I contacted Groupon to give the company the opportunity to respond to my assertions here, but it has declined to comment (SEC regulations typically prevent pre-IPO companies from making public statements).

My points here are not idle speculation. I believe that without significant business model changes, Groupon could cease to exist in the next 12 to 24 months. The company’s recent product announcements seem to be rehashes of long-established online commerce plays (travel, liquidation of unwanted goods) or products that will have little short-term impact (Groupon Now).

A successful IPO will alleviate some of these issues in that it will give the company more of a cash cushion. But the increased scrutiny that comes with being a public company will bring even more attention to every move the company makes. If that news continues to be negative, it will weaken confidence in Groupon.

This same analysis (except my reference to the City of Chicago, of course) applies to all of the companies in the group buying space, with the exception of Google. (Google’s sizable cash horde makes credit risk and consumer confidence non-issues.)

Last week, we saw BuyWithMe, another group buying company, lay off more than half of its staff after it failed to secure more financing. BuyWithMe didn’t have nearly the scale that Groupon does, but what happens to it could be a good indicator of what will happen with Groupon.

Rocky Agrawal is an analyst focused on the intersection of local, social and mobile. He is a principal analyst at reDesign mobile. Previously, he launched local and mobile products for Microsoft and AOL. He blogs at and tweets at @rakeshlobster.

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