When Groupon Dodged Google

Every so often in the land of high tech, a large merger or acquisition is assigned epochal significance, as if it marked a geologic shift under Silicon Valley. The AOL-Time Warner (TWX) merger in early 2000, which ultimately evaporated some $200 billion in shareholder equity, was soon seen as the gateway to the dot-com bust. Six years later, Google's (GOOG) $1.65 billion purchase of video sharing site YouTube supposedly put the Valley back on track and ushered in the Web 2.0 boom.

Even failed buyout attempts, it seems, can be portentous. On Dec. 3, news began to spread that Groupon, a website specializing in local shopping deals, had rejected a staggering $6 billion buyout bid from Google—and an army of tech analysts, bloggers, and tweeting entrepreneurs has been deconstructing the snub ever since. According to these armchair observers, the spurned marriage proposal marks either the creation of a new tech bubble (is it Bubble 2.0 or 3.0?), the emergence of a new strain of entrepreneurial hubris, or a surging faith in the long-awaited return of the initial public offering market for risky but rapidly growing new Internet companies. Or all three.

What no one disputes is that the Chicago startup, just two years old in November, has discovered a novel method of local advertising that shows a remarkable level of profitability and revenue growth (an estimated $500 million a year and counting). Groupon sends out a daily e-mail to 35 million subscribers in more than 300 cities around the world. It has a staff of around 3,000, including many phone jockeys who sit in a Chicago warehouse and entice local businesses to offer steep discounts on their wares in exchange for driving more foot traffic to their stores and perhaps snaring new customers. Then a cadre of writers, many with backgrounds in stand-up comedy, uses piquant prose to describe discounts on everything from pastries to spa treatments to flying lessons—typically one deal a day in each market. When enough people sign up for a given deal, Groupon splits the revenues 50-50 with the local business, and everyone seems happy. "We think the Internet has the potential to change the way people discover and buy from local businesses," says Andrew Mason, Groupon's 30-year-old chief executive officer, who went from playing in a Billy Joel tribute band to counting his millions in a few years. "What we've done so far at Groupon is just the beginning."

Polarizing Move

Groupon's rejection of Google's $6 billion—a number worth repeating, since the search giant's previous largest acquisition was $3.2 billion for DoubleClick, in 2008—is as polarizing a move as Silicon Valley has seen in recent memory. (Neither would comment on or even acknowledge the unconsummated transaction.) Groupon's business model, skeptics argue, requires no special technology and is too easily copied for the young company to flourish for long. "You can set up your own daily deal website in an hour," says Ira S. Weiss, a professor at the University of Chicago Booth School of Business. Rival startups include Tippr, based in Seattle, and Amazon.com-backed (AMZN) LivingSocial, based in Washington, D.C. Among the more established players are review site Yelp and restaurant reservations king OpenTable (OPEN). Casting even more uncertainty on the market, local businesses are likely to take advantage of this competitive heat to pressure deal sites to cut their commissions. "I would have taken that $6 billion in a heartbeat," says Paul Kedrosky, a venture capitalist and Bloomberg.com contributor. "I would have been knocking over random strangers to accept it."

Groupon's true believers, on the other hand, are ready to vote Mason into the Web Entrepreneur Hall of Fame, alongside Facebook's Mark Zuckerberg, another baby-faced CEO who walked away (wisely, we know now) from billion-dollar offers from Yahoo! (YHOO) and MTV Networks (VIA/B). They point out that Groupon has critical competitive advantages in its crowded market—a strong lead and a powerful brand—and has the potential to build a local advertising juggernaut that could one day sit beside Yahoo, AOL (AOL), and Google. "I can empathize with having a vision for a company," says Dennis Crowley, co-founder of New York startup Foursquare, which lets people use their mobile phones to "check in" at various locations. Crowley sold his previous startup, Dodgeball, to Google in 2005 but is said to have spurned a $100 million buyout offer for Foursquare by Yahoo earlier this year. True entrepreneurs, he says, "want to build and execute on that vision."

Groupon's decision to stay independent was likely made possible by the ministrations of its Russian investor, Digital Sky Technologies (DST), which poured $135 million into Groupon in April and has made a practice of buying back equity from executives and venture capitalists, thus relieving pressure to sell. (DST, which is partly backed by Goldman Sachs (GS) and Chinese Web giant Tencent, has also invested in Facebook and social game maker Zynga.) Groupon hasn't released specific numbers, but Mason has said he cashed out some of his holdings, which one person familiar with his stake put at 10 percent of the company—freeing Mason to shoot the moon without worrying about losing everything.

Google Less Attractive

For Google, the rebuff may summon up some bad memories. Several other startups it has recently pursued, including Yelp, opted to stay private, reflecting a fear among entrepreneurs that their babies will get lost inside Google's giant, chaotic nursery of ideas. There's also a sense, reinforced by a recent $1,000 cash bonus and 10 percent raise that Google paid all its employees, that the search giant is going to extraordinary lengths to retain top talent because its stock, down 4.7 percent this year, isn't the rocket it once was. "It used to be people were fine taking Google's money and stock, because they believed it would appreciate rapidly," says Kedrosky. "Now it's not as attractive."

After souring on Silicon Valley suitors, Groupon and its backers may be eyeing Wall Street. The public markets generally have frowned on risky Net plays over the past six years. A signature Web IPO for the new decade now seems inevitable—whether it's Groupon, Zynga, or even Facebook—and will mark the end of a period when acquisition by a company such as Google, Microsoft (MSFT), or Yahoo defined success. "Who is going to be the next Google? Who is going to be the next Amazon? Who is going to be the next Apple (AAPL)? The great companies we all look up to and admire are the ones that stuck around and fought," says Jason Fried, a Groupon board member. "I hope Groupon has a chance to become one of those great companies."

Whether Groupon's jilting of Google has deeper meaning—and whether Mason and his crew were prudent or quixotic—depends on how the move plays out. If Groupon can defend its turf and further lodge its brand in consumer minds, it may be on its way to a 2011 IPO that adds yet another zero to its Miracle-Gro valuation. Just as likely, a new generation of entrepreneurs will get inspired and ratchet up their own insouciance to suitors. Investors seem worried that such a trickle-down effect is the most likely legacy of this episode. "It changes everybody's frame of reference for what companies early in their life cycle can be worth," says Matt Murphy, a partner at VC firm Kleiner Perkins Caufield & Byers. "More people come to you saying, 'I think my business could be worth a billion dollars. Look at Groupon.' "

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