Groupon IPO: Mind the ratios

To really understand Groupon, you've got to go deep into its financials.

By Jeff Bussgang., contributor

When evaluating company documents and filings, a hedge fund manager friend has a simple mantra: "read the footnotes."  So when the Groupon S-1 was posted last night, I was eager to pour over it and find a few hidden nuggets that might explain the company's success and provide some indication of what the future might hold.

I think I found it on pages 74 (not the footnotes, I grant you, but buried quite deeply in the 110 page document). The company presents two case studies for its two oldest cities, Chicago and Boston, and provides datapoints that suggest two of the most important metrics for its business: Customer churn and customers per merchant.

Let's look at the longest-tenure city - their hometown of Chicago.  Here's the chart they provide in the S-1 for performance over time (click to enlarge):

How Groupon is performing in Chicago

All the numbers are growing, which is terrific.  But what matters in these situations is the ratios of growth, not just the absolute growth. So let's do some simple calculations. First, subscriber (defined as someone who receives an email from them) growth per quarter and percentage growth (click to enlarge):

Groupon in Chicago: Subscriber growth

As you can see, quarter-over-quarter subscriber growth is slowing considerably in Chicago. In Q1'10 it was 81%. In Q1'11 subscriber growth was only 37%. This is incredibly important because there are going to be inactive subscribers - also known as attrition or churn - and that number will likely grow over time. Groupon needs to fill this leaky bucket with new subscribers every quarter. If not, growth will slow, flatten or decline.

Now, let's look at customer growth. Typically, I would expect the definition of a customer to be someone who purchases a Groupon in that period. But a footnote on page 8 provides a different definition. A customer is defined as anyone who has purchased a Groupon since January 1, 2009. In other words, it is a cumulative figure representing anyone who has purchased in Groupon's history. Thus, the change in customers is far more important than the absolute number. Here's what that looks like (click to enlarge):

Groupon in Chicago: Change in customers

As with the subscriber numbers, this figure is slowing in quarter-over-quarter growth. In Q1'10, the change in cumulative customers (that is, new customers) was 69%. In Q1'11, it was 35%.

Now let's look at things from the merchant's view. The number of Groupons sold per merchant and the number of Groupons sold per customer per merchant are two important ratios of merchant success and customer activity. Here's what that looks like (click to enlarge):

Groupons/merchant and Groupons/customer/merchant

As you can see, these ratios are also in decline, with Groupons per merchant per 1000 customers dropping 10x from Q3'09 (21.3) to Q1'11 (2.3).

To be clear, I'm incredibly impressed with this company and what it has achieved. But a careful read of the rations is instructive when thinking about persistence and durability of the model.

Jeffrey Bussgang is general partner at venture capital firm Flybridge Capital Partners. You can follow him on Twitter @bussgang