Groupon IPO is hot, but its business prospects? Not.

November 4, 2011: 2:16 PM ET

Groupon's IPO is predictably hot, but that won't erase the red flags and caveats that come with its business model.

FORTUNE -- Tech IPOs are infrequent enough these days that when one happens, it's a big deal. Groupon (GRPN) is turning out to be the biggest of big deals (whether Groupon is a "tech company" is open to question, but it's perceived that way, and that's what counts). The very infrequency of tech IPOs is among the factors drawing capital to them in an otherwise fear-gripped economy where the people deploying capital are generally skittish and -- seemingly at least -- careful.

Maybe it's just that "tech IPO" carries a certain happy nostalgia for a time before many retail investors knew much about mortgage derivatives.

So far, Groupon is staying on script. The stock priced at $20, raising about $700 million for the company and valuing it at $12.7 billion. That's second only to Google (GOOG), which was valued at $23.1 billion upon its 2004 IPO. Groupon shares opened 40% higher, at $28, and hit $30 just a few minutes after trading started. They have drifted down from that, but are still well above their open price, at around $28.

The Atlantic's Derek Thompson says there are two possible factors motivating people buying Groupon today. Either they "really do believe that there is a business model at the bottom of the heap of Groupons, or else they think they're smarter than the rest of the market and can spin off Groupon shares on a bunch of suckers in the weeks and months after the IPO."

Given Groupon's history and its business model, and the recent history of similar IPOs, the latter motive seems the more likely. There are some true believers in Groupon, but many of them seem to work for either Groupon or its investors. Much of the rest of the world appears focused on the seemingly endless list of red flags and caveats: Groupon still loses money; revenue growth is flat; the company's accounting practices have been questioned (and revamped); the company apparently violated "quiet period" rules;  COO Margo Georgiadis abruptly left the company to work for Google after just five months.

More fundamentally, Groupon's prospects are far from predictable. There have been complaints from business owners that online coupons lose them money (which is sort of the point) but don't bring coupon users back to buy at full price (which is supposed to be the point.) Further, there are few barriers to entry in Groupon's business, which means that it must rely heavily on branding even as competitors pile in. (Meet Groupon's groupies)

Another reason for the stock's opening-day pop: simple supply and demand. The company issued 35 million shares, or just 4.7% of the total. Add in the buzz-propelled demand and there couldn't help but be a huge price spike.

But what happens now? Bloomberg picked 25 IPOs over the past two years that it labeled "hot." Of those, 20 have sunk below their opening price - often well below. Demand Media (DMD), another Internet company with a shaky business and lots of initial investor interest, is down 68% since its IPO. If Groupon has followed the script so far, it had better start improvising soon.

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