The Biggest Headache for Investors in Groupon and Facebook

Groupon makes its money by selling coupons for goods and services. It partners with local merchants of goods and services. When you buy a coupon for a merchant’s discount on Groupon, it reportedly takes a 50% cut in the U.S.

Groupon has had a few embarrassments. On Valentine’s Day, FTD’s flowers were priced lower than Groupon’s “deals” and the online discounter had to apologize to customers. Moreover, merchants often put conditions and restrictions on Groupon discounts that dilute the value of the deal, similar to restrictions on redeeming air miles. Even so Groupon’s valuations have ranged from $1.2 billion to $6 billion to $15 billion all in the space of a year. What’s it really worth? More on that later.

Facebook is free and “always will be.” It makes its money from ads and revenues from games (if users don’t block them), albeit phone apps so far do not display ads. Michael Arrington at Techcrunch reported that Facebook is secretly building its own phone to control its own operating system. He noted that Li Ka-Shing is a Facebook investor, and he is an investor in the rumored INQ and Spotify phone project. While Facebook may remain free, it would have to figure out a way to get users to pay their phone bills.

Facebook has tremendous potential to exploit its 500 million users. In fact, one of Facebook’s fundraisers is a genius at exploitation. Goldman Sachs, the Great and Powerful Oz of Finance (just don’t look behind the curtain), has already opined on Facebook’s value. In January 2011, it valued Facebook at $50 billion when it sought to raise $1.5 billion in Facebook financing.

Rich Teitelbaum of Bloomberg News reminded the financial world that Goldman Sachs Asset Management’s anemic track record suggests that Goldman may not be the best go-to source for putting a value on an asset. Despite Goldman’s public relations hype that it employs the “best and brightest,” it trailed the average return of its peer group in every category. Goldman has an incentive to dangle a high valuation on Facebook in front of clients:

Jim Clark of Netscape and Silicon Graphics fame was irritated that Goldman wanted to fee stuff its Facebook offering with a 4 percent placement fee, a half percent expense fee, and a snatch-back of 5 percent of investors’ potential profits.

A few months earlier, Clark had invested in Facebook through another financial firm at a lower price, and the other firm wouldn’t potentially gouge him with Goldman’s 5 percent pleasure-of-your-company tax. “I don’t think it’s reasonable,” Clark told Bloomberg. “It’s just another way for [Goldman] to make money from their clients.” The question remains whether Clark bought his stake at a reasonable price.

Blankfein Flunks Asset Management as Clark Vows No More Goldman,” by Richard Teitelbaum, Bloomberg News, January 24, 2011

In January 2011, SharesPost Inc. valued Facebook at $82.9 billion on the secondary exchange. Whatever price the market will pay today, one has to be concerned about what it will pay tomorrow. Even if the future value of Facebook is say, $4 billion, Goldman will rake in fees.

Impermanent Value

Both Facebook and Groupon became successes because they are web based networks that required few management skills, minimum capital to start, and there were no barriers to entry. That is also their biggest problem. The ugly truth is that no one can tell you what they are worth as businesses.

Groupon’s successful-so-far revenue model is its curse. It’s both trying to hold its position in “established” markets, and it’s trying to expand. The problem is that web users in other countries have noticed Groupon’s success and the fact that Groupon has been paying high premiums for local established discounting web sites just to get at the client distribution lists.

Groupon’s competitors are both buying sites for the same reason as Groupon, and local entrepreneurs can easily copy Groupon’s business model. It seems all it takes is a good web developer, a two-page merchant agreement, and an accounting firm that can handle the taxes as a site expands internationally. Groupon may have a head, but it has no long-term competitive advantage. That puts its margins, its market share, and it’s ability to expand and hold its position in new markets at risk.

Smart investors look for highly skilled managers in industries with a long-term competitive advantage in a stable industry run by decision makers with a “here-today, here-forever” mentality. Between Groupon and Facebook, it seems Facebook has the better chance of making a case, but it hasn’t made one so far.

Facebook seems to be thinking of ways to create a loyal user base by penetrating deep within its user base. It certainly has a shot, but it is unclear whether it can maintain a competitive advantage.

Users are fickle, and young users will gravitate to the next exciting new thing. The rapid success of Catherine Cook’s myyearbook.com has to give investors pause. She started the site 6 years ago as a 16-year old high school student with a $250,000 investment from her brother, and the site is valued at $20 million. While it’s no threat to Facebook, it has a fresh look, is responsive to users, and offers new spins such as allowing users to buy each other gifts and “lunch money.”

Investors may wonder when the next bright young kid will eat Facebook’s lunch and make it look like a site for old fogies in comparison. Facebook may adapt, but it would do itself favors by disclosing its revenues, and how it plans to face up to potential competitors.

Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct associate professor of derivatives at the University of Chicago’s Graduate School of Business. Author of: Credit Derivatives & Synthetic Structures (1998, 2001), Collateralized Debt Obligations & Structured Finance (2003), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, September 2008). Tavakoli’s book on the causes of the global financial meltdown and how to fix it is: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street (Wiley, 2009).

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About Janet Tavakoli 34 Articles

Affiliation: Tavakoli Structured Finance, Inc.

Janet Tavakoli is the founder and president of Tavakoli Structured Finance, Inc. (TSF), a Chicago based consulting firm providing expert experience and knowledge about maximizing value in the capital markets in the face of complexity and uncertainty. TSF provides consulting services to financial institutions, institutional investors, and hedge funds.

Ms. Tavakoli was years ahead of the financial industry predicting lax underwriting and misrating of structured financial products would result in the collapse of the global credit bubble. She also predicted the collapse of the thrift industry, Long Term Capital Management, and First Alliance Mortgage prompting Business Week to profile her as "The Cassandra of Credit Derivatives." [2008].

Ms. Tavakoli pointed out grave flaws in the methodology for rating structured financial products in her books, Structured Finance & Collateralized Debt Obligations (2003, 2008), and Credit Derivatives (1998, 2001). She wrote the first letter the SEC posted in February 2007 in response to its proposed rules for the credit rating agencies; she made the case that the NRSRO designation for the rating agencies should be revoked for structured financial products.

Ms. Tavakoli is frequently published and quoted in financial journals including The Wall Street Journal, The Financial Times, Business Week, Fortune, Global Risk Review, RISK, IDD, Chicago Tribune, Los Angeles Times, LIPPER HedgeWorld, Asset Securitization Report, Journal of Structured Finance, Investor Dealers' Digest, International Securitization Report, Bloomberg News, Bloomberg Magazine, Credit, Derivatives Week, TheStreet.com, Finance World, and others.

Frequent television appearances include CNN, CNBC, BNN, CBS Evening News, Bloomberg TV, First Business Morning News, Fox, ABC, and BBC.

Tavakoli is a former adjunct associate professor of finance at Chicago Booth (the University of Chicago's Graduate School of Business) where she taught "Derivatives: Futures, Forwards, Options and Swaps".

Janet Tavakoli is the former Executive Director, Head of Financial Engineering in the Global Financial Markets Division at Westdeutsche Landesbank in London. She headed market risk management for the capital markets group for Bank One in Chicago. Tavakoli headed the asset swap trading desk at Merrill Lynch in New York, headed mortgage backed securities marketing for Merrill Lynch in New York, and headed mortgage backed securities marketing to Japanese clients for PaineWebber in New York. She also worked for Bear Stearns heading marketing for quantitative research.

She is the author of: Credit Derivatives & Synthetic Structures (1998, 2001), Collateralized Debt Obligations & Structured Finance (2003), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, September 2008), and Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (Wiley, 2009).

During her career, she has been registered and licensed with the SFA, NASD, ASE, CBOE, NYSE, PSE and the NFA and has passed the series 7, 63 and 3 qualifying exams.

Ms. Tavakoli has a B.S. in Chemical Engineering from Illinois Institute of Technology and an MBA in Finance from University of Chicago Graduate School of Business.

Visit: Tavakoli Structured Finance

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