Does Mason want to get out of Groupon?

June 6, 2011: 11:35 AM ET

By Kevin Kelleher, contributor

Troubling financials and an offering letter full of mixed messages should make investors wary about buying into Groupon's IPO.

Groupon founder Andrew Mason

Groupon founder Andrew Mason

FORTUNE --- Dear Potential Groupon Shareholder,

I'm writing this letter to provide some insight into the Groupon IPO that was omitted from the cheery, twee "Letter from Andrew D. Mason" that prefaced the prospectus filed by the group-buying startup.

You get the feeling that the original draft of Mason's letter was a lot bolder before the lawyers got to it sucked out most of its spirit. Mason wrote, "Life is too short to be a boring company." But this is boring letter, adding virtually nothing to the prospectus' 245 pages of legalese. Mason prattles on about company ideals that boil down to platitudes like "The customer's always right." This is hardly an innovative vision.

Mason is a CEO skilled at managing growth. He built a company that saw revenue increase by a factor of 15 in the year through March. Groupon wasn't just a good idea at the right time, it was an idea exploited to full effect, in ways that will be studied by founders of other startups for years to come. Groupon's overseas expansion brought international sales from 0% of revenue in March 2010 to 53% of revenue in a year later.

But it's starting to become clear that there are some more unsettling things inside the prospectus, things obscured by and even contradicted by the carefree tone of Mason's note.

Mason wastes no time in blithely declaring, "we've made investments in growth that turned a healthy forecasted quarterly profit into a sizable loss." He's clearly channeling Google's (GOOG) founders, who included a saucy and epic "owner's manual" in the prospectus for its 2004 IPO. (Since then, Google's attitude toward Wall Street has grown decidedly less cocky.)

But Groupon is no Google. Google went public with a 24% operating margin. Groupon is approaching the markets with an operating loss equal to 18% of revenue. And yet, Groupon's IPO could give the company a $30 billion value, higher than Google's when it went public.

Groupon is losing money by choice. In early 2010, the company was profitable, then it embarked on its aggressive expansion to stay ahead of competitors. Hypergrowth is expensive. Thanks to sales and marketing costs, Groupon is spending money even faster than the insane pace that it has been bringing it in. This approach, not uncommon in startups, is risky: It works if all that spending keeps revenue growing over time. But there are already worrying signs that might not be the case; according to Groupon's own data, it's already seeing diminishing returns on its investments in established cities like Boston.

This leaves Groupon in a fairly precarious financial position. Total liabilities are $534 million, only $7 million less than total assets. It may be premature to declare that Groupon is "effectively insolvent," as some commentators have, but companies hoping to go public normally wait until income statements and balance sheets are in a healthier state. There is something rushed about this IPO, as if the company is acting in desperation. Desperation is never the mark of an attractive IPO.

Groupon is burning through cash so quickly that, without new financing, it will run dry come autumn. But again, the company chose to put itself in this position. The company raised $950 million in January, but 85 cents of every dollar went toward stock repurchases for Mason and other insiders. (In 2009, Groupon gave Mason a loan to buy some shares, which he repaid only in part.)

And here is the biggest thing that should worry every potential investor. Groupon is dealing with you in bad faith. You'll have no voting rights, all voting power belongs to Mason and a few other insiders. And yet, you are expected to take on unnecessary risks -- risks that could easily have been avoided had insiders not decided to pay themselves hundreds of millions of dollars from venture financing.

Groupon's underwriters -- Morgan Stanley (MS), Goldman Sachs (GS) and Credit Suisse (CS) -- understand this. They disclosed it all in the prospectus, albeit in fine print. They might have gone a step further and told Groupon to wait until it's finances were in better order. But they know investors are acting irrationally. For them, this IPO is an acid test to see how irrational investors are willing to be to cash in on the bubble. If you buy this stock, you are effectively voting for more IPOs as shoddy as this one.

None of this is in Mason's letter. Instead there's all kind of odd language about selling out, bumpy rides and fire dancing. At one point, he declares, "Our customers and merchants are all we care about." Which of course is simply not true. As the rest of the prospectus shows, lining the founders' pockets is all Groupon cares about. That statement is either a testimony to Mason's colossal naivete or it is simply dishonest.

My guess is that it's naiveté. There is an unsettling, plaintive tone to Mason's letter, as if he were trying to figure out how he went from trying to change the world to being the public face of a glorified coupon site. "I started The Point [the social cause startup that Mason later morphed into Groupon] to empower the little guy and solve the world's unsolvable problems," he says, as if shareholders would care.

Instead, he was bulled by a cofounder into Groupon's much more modest aspiration: "To make today different enough from yesterday to justify getting out of bed." In the cheerless realm of life compromises, it doesn't get much bleaker than that. It almost sounds like Mason is chafing under the demands of Groupon, and he can't wait to get out and do something more meaningful.

But when the CEO suggests in the stock prospectus that he wants out, it should make shareholders think hard about whether they want to get in.

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