As expected, the Groupon IPO is said to be “oversubscribed,” meaning that there’s demand for more shares than are actually being sold.This by itself is meaningless: IPOs are almost always oversubscribed. And they had better be. Or the stocks would plummet the moment they hit the market.
What determines whether a deal is “hot” or not is not whether the deal is oversubscribed but how oversubscribed it is. Specifically, how many multiples of supply there is legitimate demand for–and what the price elasticity is for this demand.
In other words, if a company is selling 100 shares at $10, and there are orders for 1000 shares at $10, the deal is “10-times oversubscribed.” That suggests there will be lots of buying in the after-market, as long as the price stays near $10 and all the folks placing orders for shares don’t intend to flip them instantly.
But the key question that will determine the ultimate trading price of the stock is the price at which the demand for 1000 shares disappears.
If the stock pops to $15, will investors still buy the 1000 shares? Or will they cap their orders at $12 a share? This price sensitivity makes a huge difference in where the stock will ultimately trade.
Groupon is said to be planning to price its stock at $1-$2 above the $16-$18 price range. This suggests there is enough demand to support a trading price in the low $20s. But it does NOT suggest that there is so much demand for Groupon’s stock that the stock will pop to, say, $50. Pricing a couple of dollars above a seemingly lowballed price-range for a deal this visible is not a sign of wild demand. It’s a sign of solid demand.
But the fact that there’s ANY demand for Groupon stock at a $12-$13 billion valuation is still a head-scratcher for a lot of folks. Several analysts, myself included, have argued that Groupon is too risky to buy at this price, and the “consensus” seems to be that Groupon should trade around $5-$10 billion. So why are sophisticated investors willing to pay so much more?
One reason is that, as in most IPOs, the underwriters will likely be handing out free money. If they price the Groupon deal correctly, the stock will trade up 10%-20% in the after-market, and buyers will book an instant 10%-20% gain. Many of these buyers will instantly flip the stock, even though they will have told the underwriters that they’re planning to buy more in the after-market (they may eventually buy more, but they may also lock in an instant gain).
But some investors may legitimately think that Groupon is worth $15+ billion.
And one reason they may be thinking this is that the underwriters are quietly circulating very optimistic earnings estimates to institutional investors.
For example, we are told that the estimates Goldman Sachs is using for Groupon are as follows:
GROSS BILLINGS: $5.8 billion
REVENUE: $2.3 billion (40% of gross billings, + ~40% year over year)
GROSS BILLINGS: $8.3 billion
REVENUE: $3.3 billion (40% of gross billings, + ~40% year over year)
In other words, Goldman is telling prospective IPO investors that Groupon will earn almost $1 a share in 2013.
If Groupon DOES earn $1 a share in 2013, and the company’s growth rate still seems compelling, then a stock price in the low $20s for Groupon makes perfect sense.
But will Groupon really earn $1 a share in 2013?
That estimate seems pretty heroic.
Given two recent Groupon trends–a major deceleration in revenue growth and a decline in the “take rate” (the percentage of gross billings Groupon keeps as revenue)–assuming 40% revenue growth and an increase in the take-rate for the next two years seems very aggressive.
Assuming that Groupon will earn $0.84 on revenue of $3.3 billion with 700 million shares outstanding and a 35% tax rate, moreover, suggests that Groupon will generate nearly $1 billion of operating income in 2013. This would be a 30% operating profit margin, which is a spectacular operating profit margin, especially for a company that is still losing money.
So those estimates seem pretty aggressive. They’re also vastly higher than the Groupon estimates published earlier this week by analyst Ken Sena of Evercore Partners, who is not on the underwriting team. Sena estimates that Groupon will lose $600 million in operating income in 2013, not generate $1 billion. This would produce a loss of about $1 a share in 2013, not earnings of $1 of share.
But, anyway, those are the estimates that we’re told Goldman is using to drum up demand for Groupon shares.
(We haven’t confirmed these estimates with Goldman. We suspect they’re not distributing them officially or in writing. If you’ve heard differently and our source has been misinformed, please let us know.)
(By the way, don’t you wish that YOU were important enough to be told what estimates Goldman is sharing with its biggest clients? Doesn’t this seem like an unfair advantage that is being given to Goldman’s huge clients? If a Goldman analyst–or anyone else acting in an official capacity–really has generated estimates for Groupon, we would certainly like to know what they are.)