The Missed Red Flags on Groupon

The Groupon case is an interesting look at IPOs and how the investment banks that underwrite them suffer from very real conflicts of interests.

Groupon’s initial filing for an IPO valued the company at around $30 billion, but after the SEC found accounting and disclosure problems analysts decreased their valuations to as low as $10 billion. The article below raises an interesting question. If the investment banks (Morgan Stanley, Goldman Sachs, and Credit Suisse) fought so hard to win the underwriting mandate for the IPO, shouldn't they have caught these warning signs? Or as former SEC chief accountant Lynn Turner said, have they simply become sales and marketing agents? The article suggests that the higher fees associated with a higher valuation could be a reason the underwriters turned a blind eye. But shouldn't they also act in the interest of their institutional clients and the general public?

The underwriting firms seemed to have turned a blind eye and let several things slide. First, many have questioned the high valuation of $30 billion, especially given the company’s slowing growth rate and unsustainable working capital deficit. The above-mentioned accounting gimmick refers to a new metric that Groupon introduced in it’s filing, in which it conveniently left out major expenses such as marketing and acquisition-related costs. In addition, since the initial filing the SEC has twice forced Groupon to change the way it records revenue. Although technically legal, the previous methods for recording revenue were misleading investors on how fast Groupon has grown over the past two years. And since revenue was one of the main drivers for Groupon’s lofty valuation, lower revised revenue figures significantly altered the valuations in a very negative way.

However, it is hard to believe that investors were actually fooled by some of the metrics Groupon used. The generous valuations that were given to companies like Groupon and Linkedin have more to do with the hype surrounding their IPOs than the actual numbers involved. In a tech bubble-like scenario, firms can get away with much more "creative accounting," as evidenced by the fact that Zynga too created some obscure accounting metrics in their filings, and is now being valued at $15-20 billion.

But the investment bank’s role in all of this is a little more nuanced. Of course, it has to appease the interests of the company who is IPOing (and who wants to raise as much money as possible), but on the flip side it has to appease the interests of its institutional investors who are buying into the IPO (and who want to pay the lowest price possible to buy the company's shares). Therefore, it is still in the investment banks' best interests to properly value companies like Groupon and to raise the red flag when they see questionable accounting. At the end of the day, they might get higher commissions from the company for raising more proceeds in the IPO, but they will sour their relationships with institutional investors who get screwed over by overpaying for the company's shares.

In the Groupon case, it comes down to the fact that, like the rest of the market, investment banks got caught up in the hype of all of these tech IPOs. For example, Linkedin IPO'd at a ridiculous valuation (something like 17.5x 2010 sales), and yet it's stock more than doubled on the first day of trading. For the underwriters who led the IPO (Morgan Stanley, Bank of America Merrill Lynch, and JP Morgan), it was a win-win situation - the company received a generous valuation and its institutional investors made a killing. It's not really a surprise that the investment banks overlook some of these accounting gimmicks because, in a bubble-like environment, they can get away with it.

http://dealbook.nytimes.com/2011/10/17/the-missed-red-flags-on-groupon/

-- Sameen

Chelsea FC Lose Stadium Vote

The Chelsea Football Club has just lost their bid to re-purchase the land of their home stadium, Stamford Bridge, located in Southwest London, from Chelsea Pitch Owners. Chelsea Pitch Owners was a fan group set up in 1993 when the club was in financial difficulties and they “acquired the freehold of the pitch to protect Stamford Bridge, which has been Chelsea’s home for 106 years until then, from developers”.

The management team of Chelsea FC was hoping that through negotiations and a voting session, Chelsea Pitch Owners would sell their shares back to the club. However, at the crunch meeting in the Great Hall of Stamford Bridge today, only 61.6% of votes cast by the shareholders in Chelsea Pitch Owners were in favor of selling the freehold of the land on which the Stamford Bridge stadium sits. In order for the vote to have passed, there needed to be at least 75% vote for the proposal.

The result from today’s meeting would mean that Roman Abramovich, the Russian billionaire who has been the owner of Chelsea FC since 2003, has to postpone his ambitious plans for the expansion of Stamford Bridge. He has his reasons though, since the stadium has a current capacity of only 42,000 seats which puts it at a financial disadvantage from rivals such as Manchester United (Old Trafford Stadium 76,000 seats) and Arsenal (Emirates Stadium 60,000).

Records show that within a five-year span (2003-2008) of Abramovich buying Chelsea FC, he has already spent approximately £600 million on the club. And if he wishes to expand the club now, by purchasing the land of the stadium out of his own pocket, he might have to pay another £600 million for the “prime real estate”.

Jennifer

http://www.bbc.co.uk/news/business-15481301

Investing in...Nigeria?

Nigeria, the tenth largest producer of oil worldwide, is beginning to amass its own wealth. While $59 billion in revenues from oil were generated in 2010, the federal government has no funds. How is it possible? Nigerian officials have often used savings “in reserve” for nationwide projects, the withdrawals never needing approval. Combined with public corruption and rampant poverty, it is unsurprising that any investor would consider entrusting their funds to the Nigerian government.

This is all about to change, however. Nigeria is beginning to craft a new sovereign wealth fund- revenue surpluses not used for immediate cash or consumption are invested in a federal account of financial instruments (assets normally held include stocks, bonds, property, and precious metals). Thus, Nigeria has been able to invest for its own future benefit. The wealth fund also provides Nigeria with a hedge against resource risks, as 80% of revenues come from oil. These include volatility of its oil prices and limited supply.

It is not Nigeria’s first sovereign wealth fund. They have, in fact, continued to run its original with little success. The fund, begun in 2004 as a means for nation savings, accumulated up to $20 billion in funds. Now, however, it holds less than $1 billion. It is clear that more regulation will be needed in this case for the sovereign wealth fund to sustain itself in the long run.

The fund has many leaders, however, which enables Nigeria’s future success. The fund will be managed by a former E&Y and Goldman Sachs employee from London, an experienced financier and Nigerian native. Along with JP Morgan, the fund will be structured to prohibit unnecessary withdrawals. Assets will be specified to serve a purpose, such as for investment in country infrastructure or education. If the right measures are put in place to profit on oil revenues, Nigeria may grow to be one of the wealthiest countries in the EMEA region.

-Zeena Advani