Last Friday, the leader among daily deal websites, raised $700 million in its IPO, valuing the company at $12.7 billion and making it the largest public offering since Google’s in 2004 (with its $1.7 billion raised).

A few minutes after the trading started, Groupon’s stock (GRPN) had increased by +30% before it started to fall sharply. The stock’s price is now around $25, which is still $5 above the opening price. Groupon only opened 5.5% of its capital to public investors (i.e. 35 million shares and $20 per share), an unusually low percentage compared to other IPOs in the high tech industry, which makes some analysts think the company intended to boost demand by limiting supply.

Two major factors could actually drive investors to buy Groupon’s stock: an actual faith in the company’s business model and ability to generate revenues on the long run, or short run speculative considerations.  So let’s take a closer look at the company’s business model.

On paper, Groupon’s idea looks pretty smart. They convince small businesses to offer extremely high discounts to buyers, in exchange for what they get access to a very large customer base. The average discount for a deal being about 50% and lasting for a couple of days, Groupon campaigns usually drive a lot of demand very quickly, and therefore a lot of foot traffic inside the stores offering a deal.

Let’s try to assess Groupon’s revenue model on a typical business case. Imagine a consumer good normally sold at $100. If our merchant’s margin is about 30% on this product, they would normally make $30 out of each sale. But as we said earlier, a Groupon deal generally features a 50% discount. Groupon then takes a 50% cut on every coupon sold. Finally, keep in mind that about 80% of buyers “only” actually redeem their coupon. So the bottom line is: on each product sold, Groupon makes $25 and the merchant looses $39. This sounds like a very expensive marketing campaign for a small business.

As far as cost goes, Groupon does not need any infrastructure for storage, logistics or distribution since the merchants handle everything. In addition, Groupon’s treasury should be highly positive since buyers pay directly online, while the daily deal company pays back merchants over a 60-day period – the first payment happening within 5 days, the second one within 30 days and the final one 60 days after the deal was closed. So basically, Groupon’s model looks like panacea. And it would certainly be, if the daily deal leader was a real Internet company, the kind of company that has very low marginal costs and the ability to scale with the speed of lightening.

But Groupon is not exactly this kind of business. This would be flouting its huge cost structure. Because the Chicago firm does not make all of its business online, its main activity is actually fieldwork: their everyday job is to deal with new merchants, conquering more and more markets and expanding geographically. This is done in real life, with phone calls, face-to-face meetings, negotiations and heavy marketing campaigns.

With its IPO coming up, Groupon had to open its financial reports to the public. It revealed that the company had paid $208 million in marketing and $178 million in sales force for the first quarter of 2011. Groupon is actually far for being profitable; it looses more than $100m every quarter and its growth is flat. With Google and Amazon entering on the coupon market, pressure is going to increase.

Considering Groupon’s alarming financial results, the daily deal market getting more and more competitive, and small businesses complaining about the inability of Groupon campaigns to retain customers, one may have to think twice before buying stocks if their goal is long-term investments.

By Fabien Punin