Groupon’s Raw Deal for Main Street

11/04/2011 11:30 am EST

Focus: STOCKS

Igor Greenwald

Chief Investment Strategist, MLP Profits

The online discounter’s red-hot IPO is monetizing small-business desperation, writes MoneyShow.com senior editor Igor Greenwald.

It’s been a tough year on Wall Street.

Trading profits have shriveled because some clients no longer have the means to gamble and others don’t care to after learning how the house used to stack the deck. Frank-Dodd restrictions, porous though they may be, threaten to make the racket even harder

The mom-and-pop investors have mostly fled as feverish speculation by machines drives volatility, discrediting the market as a reliable and liquid store of wealth.

Occupy Wall Street provided an address for complaints about economic inequality.

And then, like a rotten cherry atop the moldy cake, came MF Global (MFGLQ.PK), with its tale of reckless gambling by a feckless master of the universe and missing client funds. There are also suspicions of insider trading in the case, soon after the sentencing of a hedge-fund manager who got rich on illegal tips and the arrest of a respected business leader accused of leaking some of that information.

You can’t buy negative advertising like this. But Wall Street earned it.

Finally, though, better news is at hand, as Groupon (GRPN) makes its market debut in the biggest Internet-themed initial public offering since Google (GOOG). This could be spun as a tale of Wall Street at its best, supplier of capital for innovation.

Unlike Wall Street, Groupon shares have been in demand. Investors have bid up the limited share float on offer to value the entire company at $13 billion—more than Research in Motion (RIMM).

It’s possible to cheer the online coupon marketer as job creator, business pioneer, and all around entrepreneurial miracle.

That’s if we overlook the selective disclosure and creative accounting reminiscent of the dot-com bubble days. And also the fact that, like Wall Street, Groupon uses a very big straw to drink Main Street’s milk shake.

It is, in the words of Rocky Agrawal at TechCrunch, in the business of “getting other people to sell their dollars for 50 cents and charging them 25 cents for the privilege.”

The omnipresent problem Groupon purports to solve is a shortage of customers—customers missing because they’re unemployed, shopping online, or patronizing the national chains with scale and pricing power. Concepts foreign to the occupants of semi-vacant strip malls waiting in vain for business to pick up.

Groupon’s pitch to the desperate restaurant and salon owner is simple: promote yourself to a multitude of new customers who’ll beat a path to your door, drawn by the 50% discount, and come back for more at the full price. Groupon’s many competitors, including Google, offer a similar proposition. And no doubt there are merchants for whom the premise works as advertised.

But there are others who find selling at a loss to scrape up business a draining experience. For businesses struggling to make ends meet, Groupon can become a payday loan, securing immediate cash flow in exchange for steep discounts on future business.

For Groupon to provide long-term value to its ballooning merchant client base, there would have to be millions of long-term customers out there waiting to be won. That’s a fantasy in an era of stagnant incomes and high unemployment, in which competition for the consumer dollar is very much a zero-sum game.

The endgame here is roving packs of discount seekers dining and manicuring in whatever place Groupon is pitching that day, while competitors patiently wait for their turn to lose money in the same manner. Those half-price deals are stealing full-price business from someone else; they’re not stimulating much additional spending, if any.

We don’t know how many merchants are repeat Groupon customers, because the company doesn’t see fit to share that information. It’s likely to be small, though, possibly as low as 10%.

The mixed reviews from merchants and Groupon’s slowing growth metrics in some of its more mature markets suggest the business model may not be sustainable. With a marginal value proposition for the customer and a high churn rate, Groupon is likely to slow down sooner rather than later.

The best thing it’s got going for it is Wall Street’s marketing muscle, and also the fact that the economy is hardly poised for takeoff. There are plenty of merchants out there, for now—hungry for business and cash flow at almost any price, as long as it comes with the promise of more later. Groupon will be monetizing that hunger today.

But if predatory marketing is really the Next Big Thing, we’re in bigger trouble than we imagine.

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