Monday, November 14, 2011

Value Investing And The Groupon IPO

Value investors should stay away from IPOs for a plethora of reasons. Rarely are those reasons so well exemplified as they were in the case of Groupon's IPO, which occurred about two weeks ago.

Groupon is the well-known daily deal advertiser that has generated strong consumer interest. But its lack of profits and short history make it very difficult to value. Since value investors like to buy at a discount to intrinsic value, the determination of a reasonable range for a company's intrinsic value is crucial. But that doesn't appear possible in this case.

Groupon doesn't make money, and has only been around for four or five years. Coming up with an intrinsic value for this company is an exercise in futility (though this won't stop even value-oriented people from trying), involving a number of assumptions about growth, margins etc. that are more likely to provide the investor with a false sense of confidence than an accurate valuation.

Further complicating this IPO process is that it appears to be a marketing ploy on the part of the company. Groupon only issued about 5% of its outstanding shares as part of the IPO, which appears to be an attempt to limit supply. At the same time, it offered these shares at a price that would be attractive to buyers, creating a huge pop on its first day of trading. In so doing, such an issue can appear like a winner and thereby attract speculators who like to buy stocks that show positive momentum. This way, the company will be able to issue more shares at a better price later.

This is not the type of game in which the value investor should participate!

Disclosure: No position

1 comment:

Alan Shouls said...

Aswad Damodaran posted a valuation of Groupon on his blog that I found quite interesting.

Very much enjoy your blog.