An investment banker’s perspective on Groupon, M&A and a potential IPO
As someone who has spent more than a decade and a half helping shareholders increase and capture value, the talk about Groupon turning down an alleged acquisition offer from Google is very interesting to me and compelled me to share some thoughts on the matter.
While the amount of the offer has been reported at up to $6 billion, those well versed in M&A (mergers and acquisitions) know that the offer price doesn’t tell the whole story. The announced “value” of a deal could be masked by many different deal stipulations that could make the real value to shareholders very different than what is announced. These terms could include:
Earnouts: Some of the announced value could be tied to business performance metrics, such as Groupon hitting a certain level of sales or profits over the next several years. This type of term, especially when the business is controlled by another company in the future, is considered fairly onerous by selling shareholders.
Stock Payment: $6 billion doesn’t necessarily mean $6 billion in cash. This could come part or all in stock, which may have lock-up periods attached to it (meaning that Groupon shareholders can’t “cash out” the stock for some time).
Other Provisions: The deal could have any number of strange provisions or that a number of employees would lose their jobs, which could make the deal not as attractive.
Without knowing the financial terms of the deal, as well as the specifics of Groupon’s financials, it is impossible to know if a sound decision was made. It has been speculated by some sources- and even advocated by others- that Groupon’s holdout was to wait for an IPO (initial public offering) as its exit strategy. However, having been through this evaluation with many clients and potential clients, I can’t help thinking of the phrase, “pigs get fat but hogs get slaughtered”. Or do they?
A company’s value in an acquisition is of course whatever another buyer is willing to pay (which with a strategic buyer can be driven by business synergies). But from a market benchmark perspective, a company’s value is comprised of both things in the company’s control (sort of), such as their own performance, as well as things out of their control, like general market sentiments and valuations.
It has been reported that Groupon has sales anywhere from $150 million to $500 million or more. Let’s say for argument’s sake that they had $250 million in sales over the last year, implying a valuation of 24 times trailing 12-month sales. Now that may seem like a steep valuation, but if Groupon had a pre-filled pipeline where they really felt they had visibility to do, say, $1 billion in sales next year, the multiple would be just 6x forward sales. But while Groupon may have control over their own performance, they can’t control what the market does.
Right now, there is very aggressive pricing in the tech center, particularly as it pertains to “Web 2.0” companies. However, any number of market factors, from a general market correction in that sector to decreased consumer confidence could decrease valuations sharply. The likelihood of 24x sales (or anything in that ballpark) being a sustainable multiple of sales is not one I would be willing to bet on, all other things being equal. Not to mention if their growth slows, then the rich multiple given to Groupon for being a super-high growth entity will also retract.
Plus, an IPO can also be risky for a company whose long-term viability is questionable. While undoubtedly the flavor of the month, whether Groupon can sustain its business model and continue to grow at a rapid clip is unknown. Value is fleeting and business lifecycles are shortening. While it took Blockbuster a few decades to peter out, newer entities are facing shorter cycles for their businesses. This can be a problem because while an IPO is often comprised of selling primary and secondary shares- meaning, new shares sold by the company to raise money and shares of existing shareholders sold to investors where the selling shareholders retain the proceeds, respectively. And it is often the case that the number of secondary shares- those that can be sold by existing investors- is limited, as an investor wanting to get rid of their shares is seen as a negative signal by the market. So, if Groupon goes public, its shareholders may not be able to sell a large percentage of their shares during the IPO. And then investors are usually subject to lockup periods- again limiting the number of shares they can sell and the time periods in which they can do so, to avoid downward pricing pressure on the stock from the appearance that the shareholders are “dumping stock”.
However—and this is a big however, the word on the street is that there wasn’t a formal M&A sale process for Groupon and that Google may have approached them opportunistically (outside of an organized process). M&A is a very methodical dance between companies, and it takes a huge amount of coordination for corporations to organize their deal teams (typically dedicated executive team, lawyers, investment bankers and accountants) to shop their company for sale. In this case, other prospective buyers (for example Yahoo!) may also be interested in buying Groupon. If Google approached them unsolicitedly, it may be attempting to lock others out of a process so that the purchase price for Groupon is not bid-up competitively. A competitive process can also garner more favorable deal terms as well. Groupon may have rejected the offer in favor of filing an S-1 (the IPO registration statement) to let other buyers “come out of the proverbial woodwork”. A sophisticated investment banking firm should be able to run a dual-path process where Groupon marches toward an IPO, but also shares confidential information with a select group of highly qualified buyers. This scenario allows the shareholders to truly maximize their options and choose the path in the best interest of the company.
Plus, remember that it is not just Groupon’s founders that are shareholders here. There are sophisticated institutional investors involved. These may be the ones holding out for a higher price, and given the types of term sheets that VC’s usually put forth with private companies, they are likely the ones who would be able to liquidate their stock first in an IPO.
If the market holds up and the value increases, or if an S-1 creates market competition, the Groupon shareholders will be thought of as geniuses. If the market doesn’t hold up, or if the company doesn’t perform, or perhaps some of each, they will be heralded as fools.
Without looking at all of the facts, we will never know if this alleged deal was a good one or worth saying “no deal” to; all we do know is that hindsight will certainly be 20-20.
