Last week the company laid off ten percent of its staff, citing struggles with profitability. But the picture we’ve since heard is a lot more dire. Our sources tell us LivingSocial has less than $50 million in cash left and is making the rounds, trying to raise more money right now. Only these days, investing in the No. 2 daily deals site doesn’t sound as appetizing as it might have a year ago. LivingSocial is also likely looking for a white knight to acquire it, given the position it’s in. If that’s the case, its investment from Amazon could be a blessing or a curse.
The odds of raising another round or structuring an acquisition will depend on how healthy LivingSocial’s underlying business is. And if Groupon is any indication, it’d be doing well to hold steady. Groupon’s core deals business in North America is actually shrinking, and the company is frantically trying to expand into other verticals and business lines.
It’s important to say we have not had this perilously low cash reserve confirmed directly from the company or existing investors. [Update: Lightspeed's Jeremy Liew wrote just after publication to say things are actually getting better for the company, cash-wise. More on that below.] But given reports we’re hearing that the company is seeking money, there are several people out there who’ve been briefed on its position. If our sources are correct — or really even just in the ballpark of correct — LivingSocial’s costs mean it is rapidly running out of options.
It’ll take us a little while to unpack all the details we’ve heard, but in essence it boils down to this: If Groupon has the flu, Living Social has pnemonia. As botched as the premature IPO was for Groupon, it did two things that dramatically helped Groupon’s prospects for a turnaround. First, it got the company a ton of visibility to solidify its No. 1 position in the market. Second — and more important — it gave Groupon a cash trove of more than a billion dollars. Neither saves the company, but both are luxuries that can buy Groupon time. LivingSocial isn’t so lucky.
While $50 million might sound like a lot of money for a startup to be sitting on, it’s not for a business like this. Remember: Both LivingSocial and Groupon pay small merchants after their promotions run. These daily deals companies rely on new money coming in from new deals to pay off the old. The merchants are essentially lending LivingSocial money for a matter of days, or even months. It’s a great business model as long as you keep selling stuff — far more enviable to classic retailers who have to pay up front for inventory. But without a strong cash position and growing sales, it can be a terrifying, white-knuckle way to live.
Since LivingSocial isn’t public, it’s hard to know how big that balance is. But in the case of Groupon, its merchant payables are just under $600 million. Fortunately Groupon has $1.2 billion of cash. So even if Groupon’s income went to zero, it could easily fulfill these obligations.
If LivingSocial is remotely in spitting position of Groupon’s market share, $50 million isn’t going to cover what it owes merchants in a worst case scenario. Even if our sources were wrong and they had $100 million in the bank, it wouldn’t cover it.
To be clear, if LivingSocial’s deals are steady to growing — or even just declining modestly — this isn’t an immediate disaster. But even if the new deals can repay the old, the lack of a guarantee might put off LivingSocial’s mom and pop merchants who are trusting they’ll be repaid. The doomsday scenario would be a panic that could effectively cause a “run on the bank,” if merchants got spooked and all demanded to be paid immediately. If I were Groupon, I’d be using the fact that I have a public balance sheet and a strong cash position to my advantage here to gain share.
And, there’s another demand on that remaining $50 million: those layoffs from last week. It costs money to lay 400 people off. The laws and requirements can be particularly onerous overseas. In many countries, labor laws prevent you from simply scaling back when the business demands it (another reason to rethink the kind of rapid international expansion Groupon and LivingSocial did). Ironically, bigger layoffs would also be a bigger drain on immediate cash. Our sources estimate that last week’s layoffs have cut LivingSocial another few months of slack — maximum. (Liew’s statements below seem to contradict that, though.)
The hope during that time, we hear, is getting some kind of deal done. Finding investment is a challenge. Most of the leading venture firms got burned on their late stage Groupon deal, breaking even at best after a big embarrassing PR splash. If Kleiner Perkins, Greylock, Andreessen Horowitz and others were burned on the number one player, few traditional firms are likely to take a gamble on the number two.
That doesn’t mean LivingSocial can’t find money somewhere. Many were surprised that Tiger Global came in to buy 10 percent of Groupon recently. But a deal like this for LivingSocial would be a contrarian play, likely to get a lot of negative press. The category is widely seen as a disaster zone in the press and on Wall Street. That’d be one ballsy deal to do. An investor would have to be pretty sure that there was upside there somewhere. Even Tiger Global’s investment is seen as more of a value play, than a growth investment. And remember, Groupon has more than $1 billion in cash propping that valuation up somewhat.
That leaves the other option, an acquisition. For all the warts of the daily deal space, there are many large Web players who would love a better way to help small businesses market themselves. Execution issues aside, Yahoo, Google, AOL and the like have been chasing a local small business product since the late 1990s, and Groupon was the closest anyone got to competing with inefficient offline models like the Yellow Pages. Laugh at it all you want, there’s still value there in the premise.
Amazon’s investment in LivingSocial could either hurt or help here. Perhaps, if LivingSocial has something Amazon wants, it could be a glorious white knight and perfect answer for the company. After all, Amazon has an extraordinary ability to go long on things that don’t look profitable now. If there is value there to unlock, and Jeff Bezos sees it, he won’t give a shit what Wall Street thinks about the move.
After all, this is a company that embraced Zappos’s extraordinarily expensive customer service and happiness-oriented ways of selling shoes, and is at least tolerating Zappos’s CEO Tony Hsieh spending the bulk of his time rebuilding Downtown Vegas. To some, the daily deals space may seem comparatively sane to the risk of rebuilding sin city. (Although Hsieh is using his own cash, not Amazon’s.) If you buy that the macro-thesis of daily deals had merit — which many people still do, even if they don’t want to say so out loud — this could be a win-win for Amazon and LivingSocial.
But Amazon is an extraordinarily disciplined acquirer. It is unlikely to do the deal simply to bail out a flailing investment. What’s worse, if the value isn’t clear to Bezos, his previous investment could hurt LivingSocial at this vulnerable time.
Google is another possible buyer. They wanted Groupon to the tune of $5 billion pre-IPO. They clearly see some value in the space…or did. It’s likely LivingSocial could be appealing at some price. But given the competitive dynamics, if Google came in, Amazon would likely block the deal. And that might make Google less likely to even get embroiled, since this isn’t something they have to own. This is one reason taking money from strategic investors isn’t always as great as advertised.
What about Yahoo? Yahoo has long wanted a better way to sell ads to small businesses as well. It’s hard to know what Marissa Mayer is thinking right now. So far, she’s been less acquisitive than many expected when she took the job. But this is a deal that would likely look bad to the press and Wall Street considering the Groupon fallout. Giving the position Yahoo is in, that may alone be enough to scuttle it, unless there was huge upside we can’t see from the outside.
And any of these three potential acquirers would have to take on a large headcount of more than 4,000 people and a huge sales team. That may make the deal less appealing as well.
A lot of this will boil down to whether LivingSocial’s core business is growing or not. Again, Groupon has the advantage of being the more visible market leader, and its core daily deals business is not.
There are some hints from Amazon’s earnings. As AllThingsD detailed last week, when it wrote about the layoffs, in the third quarter, LivingSocial had an operating loss of $565 million on revenue of $124 million. Operating expenses were reported at $193 million.
Back in October, AllThingsD published a memo from CEO Tim O’Shaughnessy saying the losses were mostly non-cash items related to acquisitions that were no longer worth what they were a year ago. (Again, no doubt some of this is that rapid international expansion coming back to haunt them.) They report, on an up note, that LivingSocial had positive operating cash flow for the first time since 2009. But ATD says there’s still a $70 million shortfall each quarter that needs to be made up by revenue or cuts.
We reached out to Lightspeed’s Jeremy Liew, who is on LivingSocial’s board, before press time and he emailed us back just after we published to say — contrary to what we’re hearing — he’s actually encouraged by the discipline the team has shown getting to positive cash flow. He says the company is in a far better position than it was. He wrote the following, painting a dramatically different version of the company than either Amazon’s earnings statement or our sources:
With the recent cost cuts (actually before) we’re now cash flow positive and growing share against group on wherever we compete head to head, so we are in control of our own destiny. We’ve definitely got wood to chop for a while to build further scale, and to show the world that we are a different and better run company than Groupon, and that won’t happen overnight, but I actually feel great about what Tim and his team have been doing. Cash position is increasing each month since we’re cash flow positive, which is obviously a huge relief relative to earlier in the year. But Tim and the team promised cash flow positive in Q4 and they delivered it.
Even if Liew is right, the company isn’t out of the woods. The last issue the company is facing is one of incentives. It has raised some $800 million in capital. And all of that capital almost certainly has a liquidation preference. In venture speak, that means that investors get their $800 million back first in the event of an exit. If Groupon is valued at $2.5 billion — with $1.5 billion in cash in the bank — LivingSocial likely isn’t getting close to $800 million, even if it can structure a deal. No new investor is going to come in, unless it gets to cram all that previous equity down. So the board is likely to want to push for an acquisition. At least they’d get something under that scenario.
But unless they strike a special deal with the management team, almost any fathomable deal would leave the investors getting everything and the employees and founders with nothing. That’s going to make the idea of merging cultures and working for a new boss for a contracted period of time a lot less appealing for the top team.
I know there are people who love to dance on the daily deal grave. People will make jokes about the company’s valuation being half off and the like. I am not one of them. I think this story, if true, is extraordinarily sad. I don’t know the LivingSocial team well, but they worked hard to compete with the wacky press darling Andrew Mason and built a great business helping mom and pop retailers. Based in Washington DC, they were a shining example that you could build a hot company outside of the Valley — for a time. They grew fast and raised lots of money, because that’s what was required to be a player here. They couldn’t have been a lean startup and kept up with Groupon’s torrid growth. But now, it seems, some of those decisions are coming back to haunt them.
To repeat, we don’t have any of this confirmed from the company itself. We reached out but did not get a response by press time. This is all information from informed sources familiar with the situation, and some of it — including their fundraising options and acquisition options — is only informed speculation from similar sources. Frequently things are not as they appear from the outside when you’re talking about the inner workings of private companies.
But even if there’s double the cash in the bank that our sources say there is, the general sketch of this story is what LivingSocial is weighing with each board meeting, as the daily deals market gets colder and growth slows even more. We hope for the sake of their remaining employees, they find an answer.