Groupon could be required to write off a huge amount of goodwill from acquisitions it overpaid for, and it may have to redefine its operating cashflow, according to two business school professors who predicted the daily deal firm’s woes seven months ago.

The accusation is another headache for the company, which is being probed by the SEC after it restated its Q4 2011 numbers. It is not known what that probe is about. The restatement did not affect goodwill or cashflow.

Writing on their blog “Grumpy Old Accountants,” Anthony Catanach Jr., an associate professor in the School of Business at Villanova University, and J. Edward Ketz, an associate professor of accounting in the Smeal College of Business at Pennsylvania State University, reach the conclusion that Groupon’s cashflow is incorrectly defined as coming from operations when it should be booked under financing.

That would make Groupon unprofitable on both a GAAP basis and in terms of operating cashflow, and imply that the company’s entire business is reliant on financing maneuvers, not the sale of coupons.

Goodwill gone bad

Here’s what they say about Groupon’s goodwill (the intangible value companies add to their balance sheets based on the difference between the value of the assets they’re acquiring and the premium they paid for it):

How do we know that a goodwill write-off is on the horizon?  Simple…the international operations to which Groupon has assigned over 75 percent of total goodwill ($126.2 of $166.9 million) is operating at a loss according to Note 14 of the Company’s financial statements.

… And in case you missed it, in 2011 Groupon made new acquisitions in India, Malaysia, South Africa, Indonesia and the Middle East, which added $36.5 million in goodwill to the struggling international segment.  Goodwill in these transactions represented over 76.5 percent of the acquisitions’ price according to Note 3 in the financial statements. Given that kind of premium, how do you think these investments will play out?

Goodwill writedowns are non-cash expenses—an accounting maneuver, really—so if they occur they will look bad but not fundamentally affect Groupon’s underlying business.

What’s wrong with the cashflow?

The cashflow problem is different, however. Currently, Groupon generates positive cashflow by collecting money from customers’ credit cards immediately and only remitting the merchants’ portion of that 30 or 60 days later. This line ballooned to $390 million in 2011. During that period, Groupon gets to temporarily keep  the cash “float,” which was $290 million at the end of 2011.

The problem is that Groupon can never keep this “merchants payable” money permanently, which means that if it experiences a decline in customers the money it owes to previous merchants may be greater than the incoming money from new customers, making Groupon’s cashflow negative. As Groupon mostly isn’t profitable on a GAAP basis either, the nosedive would be severe. Groupon admits this problem on page 20 of its 10-K filing (emphasis added):

If we offer our merchant partners more favorable or accelerated payment terms or our revenue does not continue to grow in the future, our operating cash flow and results of operations could be adversely impacted and we may have to seek alternative financing to fund our working capital needs.

This isn’t new, but Catanach and Ketz have noticed that Groupon’s operating cashflow may not be properly defined. Normally, companies generate cashflow from accounts payable by buying a product or service from another company and then delaying the payment for the goods. But Groupon never actually receives any goods or services from its merchants. Yet it holds a massive merchants payable line on its cashflow statement. In reality, Catanach and Ketz say, this is a cash transfer arrangement and thus it should be moved to the financing portion of Groupon’s cashflow statement.

This is what Groupon’s operating cashflow, and free cashflow, would look like with the merchant payables backed out, and moved to the financing section:

Catanach and Ketz conclude:

… when merchant payables are correctly excluded from operating cash flows, Groupon’s reported cash flow picture dims significantly. The Company’s operations are really burning up cash, not creating it!

In some ways this is cosmetic. All that positive cashflow simply ends up on a different part of the cashflow statement. But it might alter investors’ psychology: It would be a stark reminder that Groupon’s underlying business is unproven and that it’s dependent on borrowed money for its survival.

Groupon (GRPN) has purchased Mertado, a member access shopping site, that offers its members exclusive deals.

Mertado is similar to Groupon Goods, which offers discounted items and the supplier ships the goods directly to you. You can also deal directly with the supplier to purchase directly with your Groupon discount code.

From what I can gather, the thinking behind the purchase is to create communities around Groupon Goods.

Eileen Brown from ZDNet summed it up best:

Lots of us are loyal to Groupon itself — but we are not loyal to the brand making the offer. We go from Groupon deal to Groupon deal. We rarely go back to the brand again — unless there’s another offer from the brand itself.

To get brand loyalty, brands will need to work with Groupon Goods / Mertado to encourage loyalty amongst their social shoppers. Encouraging deals to be shared widely brings in more revenue for the brand offering the loss leader.

Groupon has redefined how local advertising works. The grouping of like-minded people drives pricing down. The brand benefits, we all benefit.

Groupon has been increasing its social commerce offerings. It acquired social messaging and engagement platform Campfire Labs whilst it was still in stealth startup mode last month. Groupon want to capitalize on the shift in how consumers will shop in the future.