Tuesday, August 16, 2011

Groupon, Enron...Moron! Stupid Accounting.

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When I was an idealistic and naive college professor, I remember that I told my students that in order to generate a profit, your actual revenues had to exceed your actual expenses; going further, I stated (strutting around like a know-it-all) that even paper profits can be misleading...that in order to generate real cash flow, the entity's actual cash inflows had to exceed the entity's actual cash outflows. In preparing and analyzing income statements, we were to be conservative.

In preparing and analyzing balance sheets (nowadays, simply "B.S."), we valued assets at the lower of either cost or market, and liabilities at exactly what was owed. We differentiated between earnings per share (eps) and fully-diluted earnings per share (the earnings per share assuming that all outstanding options and warrants and convertible debt were to become either exercised or converted into shares. It was fairly simple.

Forecasts, proforma statements or future-looking projections were at the back of the presentation bus, and were separated, explained, disclaimed and looked at with a raised eyebrow.

In the interest of accelerating the wonderful feeling that comes from becoming instantly rich, investment bankers, company CEOs and "independent" CPA auditing firms, decided to sort of collude and bend the rules a bit in order to paint a brighter picture for prospective investors, acquirors, bankers (and other lenders) and even the regulatory authorities.

The past was de-emphasized (or concealed), the present was merely a "developmental stage where funds were being invested (i.e., lost somehow) in the production of future revenues, and the future (which was always so bright that you'd have to wear shades) somehow became the "inevitable present" of tomorrow.

Remember how Enron and auditors Arthur Andersen and Company concocted a special system of "Mark To Market" wherein Enron could essentially take projected earnings and book them as if they had already been earned? Entire pension funds, retirement accounts and investment portfolios were wiped out when it became apparent that the Emperor Of Enron had no clothes. The line between creativity and fraud had been crossed.

Everyone seemed to forget about the experience within months (except those who had lost fortunes in a downhill domino disaster that would have made Ponzi, or the Mighty Madoff jealous), and creative accounting, after a brief respite, came back with a vengeance. Greed and the lure of instant gratification are indeed powerful forces...

And now Groupon, a company that sprang up out of nowhere to be a media colossus sporting a brilliant business model has confessed to the world that it has not been generating a profit. In fact, it has been losing a fortune of money -- hemorrhaging cash.

Apparently, when you (the intelligent businessperson and decision maker) pull the lid off of the ACSOI method of creative accounting used by Groupon in preparing its investor offering materials, the company's a loser. Worse, ot might not be "too big to fail" in accordance with the Bernanke Salvation Criteria. Who will save Groupon? In fact, who should save, subsidize or invest substantially (i.e., take a long portfolio position) in any company that does not have any proven fundamentals?  Especially when someone inside knew about it and either pulled it off with intent, or chose to look the other way [I can understand this, as no one likes a party pooper, or a negativist].

An excerpt from a Harvard Business Review article follows to offer you the poop on Groupon [I apologize for that lowbrow humor], and the author discusses it dignified, academic terms. He is polite, whereas I went to a State University as an undergrad.


Why Groupon Lacks a Viable Business Model

The Daily Deal site has ditched the contrived profitability metric ACSOI, but creating real profits will prove a challenge, says Harvard blogger Rob Wheeler

Posted on Harvard Business Review: August 16, 2011 10:17 AM

“All right, you caught us. We’re actually not making any money. In fact, we are really losing a lot of money.”

This is the essence of Groupon’s declaration last week that it will remove the controversial accounting metric called Adjusted Consolidated Segment Operating Income (ACSOI) from its financial statements. ACSOI essentially measures Groupon’s profits before subtracting its subscriber-acquisition costs and stock option-based compensation. The metric was an attempt to put a thin veneer of respectability on what are extremely disconcerting profitability numbers for the company.

In the first quarter of 2011, Groupon posted a net loss of $113.9 million. Yet, the company reported ASCOI of positive $80.1 million. In most recent quarter, Groupon’s losses continued to mount as it begrudgingly abandoned the ACSOI metric amidst criticism and incredulity from the SEC.

But what is most interesting about its emphasis on the ACSOI metric is that, deep down, Groupon knows what we all know: good investments are profitable investments. It was simply not enough for the firm to report earnings and explain that it was investing for growth. Rather, Groupon felt the need to include a metric of profitability, no matter how contrived, that was actually positive. [more]

InfoSphere readers and TNNWC Clients, here's the bottom line:

Watch out for gimmickry -- as the economic environment gets increasingly volatile and tempestuous, desperation will trump dignity, and accounting innovation will trump integrity. Be careful in your investing, your trend analysis (Global Futurist, anyone?) and your decision making.

Just as importantly -- don't use this kind of funky futurism to raise money or to acquire a suitor. Civil and criminal penalties may apply. Don't fib. 'tis far better to tell your tale of woe and present your turnaround plan than to engage in or to encourage this kind of conduct. This type of fraud, and those who willingly take part in it, are part of the reason that entire world economy is suffering.

As a wise old chap (one of my career mentors) once said to me, "Douglas - Stick to the fundamentals. Look behind the curtain. Walk through the smoke and mirrors and get to the back room. Look before you leap. Be suspicious of what you don't understand. Ask questions."

He said more, but I had already walked out of his office to get some lunch.

That was more than 25 years ago. But he was absolutely right.

Douglas E Castle [http://www.linkedin.com/in/douglascastle]

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