Google Gambit for Groupon Raises Concern

Google’s $6 billion bid for Groupon, an online coupon start-up, is an aggressive move by the company to dominate local online advertising and help with its long-sought move into social networking.

Google has offered Groupon $5.3 billion, with the promise of $700 million in performance bonuses for management, according to a person knowledgeable about the matter who spoke on the condition of anonymity. Several people close to the deal said Groupon, which is based in Chicago, was expected to approve the acquisition and an agreement could be signed as early as this week.

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If the deal is completed, Groupon will stand as Google’s largest acquisition, easily topping the company’s $3.1 billion purchase of DoubleClick in 2007. The acquisition would also yield giant checks for Andrew Mason, Groupon’s 30-year-old founder, and its investors, a group that includes Battery Ventures, Digital Sky Technologies, Accel Partners and New Enterprise Associates. They have invested about $170 million in the company in the last two years.

Mr. Mason, Groupon’s chief executive, declined an interview request, saying that he would talk “only if you want to talk about my other passion, building miniature dollhouses.”

The deal has worried Google’s investors, however, because of the high price and also because of doubts about how effective the company is in generating sales for merchants.

Google has compelling reasons for wanting the company, which offers deeply discounted coupons from local stores, restaurants and services. Deal-hungry buyers often mobilize their friends and family through Facebook and Twitter, which helps the Groupon concept spread.

For instance, a Groupon deal on Tuesday in Omaha offered $300 worth of laser hair-removal treatments for $149. While Groupon is focused on local business, it has also expanded to national deals; a Gap promotion last summer generated $11 million in revenue on one day.

Analysts estimate that Groupon, which says it is profitable, has annual revenue of more than $500 million.

The upstart would help Google get into local advertising and give it specific insight into consumer spending habits. Local online advertising is expected to grow 18 percent, to $16.1 billion, next year, according to the advertising research firm Borrell Associates.

It could also give Google access to a large sales force that knows the owners of the neighborhood pizzerias and bowling alleys. Groupon has 3,100 employees. “This would basically get Google the feet on the street for what they would never build themselves,” said Jason Helfstein, an analyst at Oppenheimer & Company.

As important, the viral aspect of Groupon’s business could give Google a much-needed path toward social networking. Google has been frustrated in its attempts to create a social network and it fears the growing power of Facebook’s advertising machine, which produces higher ad responses because friends in the network recommend products and services.

Groupon, whose subscriber network spans 300 markets in North America, Latin America and Europe, says it has 35 million subscribers worldwide, with 17 million in North America.

Google’s investors, however, seemed focused on Groupon’s valuation, which was estimated at $1.4 billion during its last fund-raising round in April. Google’s bid carries a fourfold premium to that. On Tuesday, some Google investors wondered if the company was paying too steep a price. Shares in Google fell 4.5 percent, to $555.71. The stock was also battered by news that European regulators had opened an antitrust investigation.

"A multibillion-dollar valuation for a company that is in a business with virtually no barriers to entry and is younger than my toddler is absurd." -Retail Analyst, Forrester Research, Sucharita Mulpuru

“A multibillion-dollar valuation for a company that is in a business with virtually no barriers to entry and is younger than my toddler is absurd,” Sucharita Mulpuru, Forrester Research retail analyst, wrote in a note to clients on Tuesday morning.

Groupon began in November 2008, growing out of an earlier company that Mr. Mason created in 2007 called the Point, which tried to rally groups of people behind charities and social causes.

Not all small businesses are sold on the golden promise of Groupon. Ina Pinkney, the chef and owner of a cafe called Ina’s, in Chicago, said she was curious about Groupon when she first heard about it a couple of years ago. She ultimately decided against using it.

“We did the math up front when they first started coming around to us and I said, ‘No, it really doesn’t make much sense,’ ” she said. “If we were to offer a $25 coupon for $50 worth of food, it doesn’t work.”

Groupon’s cut is half the dollar amount of the coupon, so the average amount of money Ina’s would collect for each Groupon customer was around $12.50, she said.

“I would never produce that much food for such a small amount,” she said.

She acknowledged that it might work better for a cupcake shop or a spa, where the material cost was much lower.

Ms. Pinkney, who uses social tools like Facebook and Twitter to help promote her business, said she was not convinced that a service like Groupon would generate repeat customers. “People don’t go back,” she said. “They just wait for the next Groupon and flock to that next restaurant.”

But for many retailers, it is less about the potential revenue a sale could generate and more about the promotional value of a Groupon spotlight and the hope it will attract new customers.

The company has grown fast. In 11 months, Groupon has ballooned from 200 employees. It moved its monthly company meeting to a local church because its Chicago headquarters, in a former Montgomery Ward warehouse, didn’t have a conference room large enough to accommodate the staff.

About 1,000 people work in the Chicago office and some 2,000 more are spread across its sprawling worldwide network, which includes the employees of its recent international acquisitions, ClanDescuento and — group-buying sites in Chile and Germany. According to Groupon, the company is adding more than 200 employees a month.

Despite increasing competition from new rivals like Living Social, Gilt City and TownHog, and what appears to be an easily imitated template, Groupon has continued to pick up revenue momentum.

Although the company’s strong cash flow is attractive for Google, the bid is highly strategic, and in part, a defensive move, said Danny Sullivan, the editor of Search Engine Land, an industry blog.

Google has big ambitions for local services, which include listings of businesses alongside its mapping service, although Google has had only modest success with the program after years of trying. The company has recently stepped up its efforts, promoting a prominent executive, Marissa Mayer, to oversee the local business in October and trying to buy Yelp, the local review site, last year.

Google fears the damage rivals could inflict if they acquired Groupon instead. Facebook, which has become a larger threat in recent years, could use Groupon to enhance its formidable position in social networking, Mr. Sullivan said. Meanwhile, Microsoft could use Groupon to erode Google’s dominance in search.

“What’s the price of not buying it?” Mr. Sullivan said.