There was a time, before ETFs and hyper trading, that forensic accounting mattered.
Thankfully, Villanova business professor Anthony Catanach and Penn State accounting professor Ed Ketz, think it’s still important—and are shining lights on the kind of numbers that tend to get lost in the translation via their blog, Grumpy Old Accountants.
Neither is particularly old (at least relative to my view of old) or grumpy, but they might as well be. Their latest, in preparation for Groupon’s pre-IPO road show this week, is headlined: “Groupon is Technically Insolvent.”
Here’s what they wrote:
Groupon issued amendment No. 6 to its S-1 filing. The most interesting data are on page 9 of the report….
What stands out to us is that stockholders’ equity on September 30 is negative—the firm has become technically insolvent! Our prediction that Groupon has a high probability of failure remains intact.
If a serendipitous IPO transpires, then shareholders’ equity becomes $464 million and financial leverage drops to “only” 64 percent.
Of course, this felicitous result depends on investors believing the firm to be valued at the estimate provided by management. But, for reasons explained in previous essays, we doubt that investors will buy those rosy projections.
Tony and Ed may be grumpy, but I just might be grumpier. I’m simply not sure investors will care (certainly not in the early going) about overriding concerns flashed by their earlier detective work—or the current detective work of others, like longtime Groupon gadfly Rocky Agrawal, who writes: “Like many Groupons, Groupon is no bargain – even at 50% off.”
My view: Sticking with one of Wall Street’s latest games, this will be a relatively small offering which all but guarantees a quick pop in the early going, and investors are likely to zero in on declining losses and growing free cash flow.
Investors also are likely to view the company as having cleaned up some of their earlier accounting discrepancies, notably the way it presented revenue, following an SEC review.
Still, a quick scan of the latest filing raises plenty of red flags, including:
Falling revenue growth;
And an apparent attempt to dress the company up for the IPO by lowering operating expenses.
That last one is really something. In the fine print of its filing, the company says: “The improvement in North American operating income [41 percent of nine-month revenue] was the result of our ability to decrease marketing expenses...in addition we were able to decrease our operating expenses at a lower rate than our revenue growth."
But that slide in expenses is fleeting. The company also says elsewhere in the filing that “we anticipate our operating expenses will increase substantially in the foreseeable future as we continue to invest to increase our subscriber base.”
But back to our grumpy old accountants and the technical insolvency: I had a few questions about their write-up—specifically, what the 64 percent leverage meant and, by virtue of going public, aren't most companies seeking an IPO technically insolvent?
Tony to me:
While we don’t have those numbers handy, I suspect quite a few “start up” companies are close to technical insolvency (i.e., liabilities greater than assets) as they go public. After all, there is a reason they are going public…they need to raise capital to execute their strategy.
Groupon is a bit different though in that the Company has been around a while, and clearly, a main reason for the IPO is for the investor group to extract their value.
Just look at the “purpose of the recapitalization” as discussed on page 6 if you have any doubts…nothing there about using the funds for growth or acquisition or any other corporate operating purpose.
Indeed, under “Use of Proceeds” the company says that “based on our current cash and cash equivalents, together with cash generated from operations, we do not expect that we will utilize any of the net proceeds of this offering to fund operations” and that “we intend to invest the net proceeds in money market funds and investment grade debt securities.”
As for the insolvency, Tony adds:
The picture is even worse if you consider the significant intangible assets recorded by the company (goodwill, intangibles, deferred taxes, etc.). We still don’t have any reported evidence of the cash generating ability of these “assets”, so future write-downs may be forthcoming.
If you deduct these assets, to get a tangible equity number, the insolvency picture is even clearer.
As for the 64 percent leverage, this is simply total liabilities divided by total assets after the IPO: (1274367 – 464104)/ 1274367 = 63.54 percent.
We still worry about all the red flags that are being ignored. For example, with all the restatements (revenue, CSOI, etc.) and amendments, this delivers a powerful signal about the quality of internal controls over financial reporting, as well as the competence of the finance function at this company.
What else are we not seeing in the numbers? Recent senior management turnover does not help, and the rapid growth adds more concern to the internal control issue. And the working capital deficit (current liabilities greater than current assets) raises further concerns.
Details, details. If we’ve learned nothing else in recent years, it’s that details like those don’t matter until they do, and then if they do it’s usually well after the fact. It’s just the way it is.
P.S.: In the early days critics (including yours truly) thought Amazon's business model made no sense. Same with Groupon. Difference is: Groupon ain't no Amazon.
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