The Value of a Strategic Buyer: Groupon and Google

Mega-hot online deal of the day distributor Groupon has been growing at a breakneck speed, and it looks as though it may be searching for more fuel.

After raising $30mm in December 2009 from Accel Partners and New Enterprise Associates, and an additional $135mm in a May 2010 round led by the Russian-based Digital Sky Technologies, the Chicago-based Groupon is reportedly in talks with Google over a strategic acquisition that has been reported to come with a price tag of up to $6B.

We’ve written in the past about how a strategic acquirer usually evaluates businesses differently than a financial buyer. While a financial sponsor is primarily interested in buying a company for the potential future cash flows it will generate, a strategic acquirer is likely interested in how a target business may potentially “tie in” with their own or pre-empt a competitor. Although Groupon is no slouch financially (it’s reportedly on pace to bring in a very profitable $350mm+ in revenue in 2010) there is good reason the two companies may be especially interested in tapping each other as strategic partners.

In an interview with The Daily Telegraph, UK-based Groupon managing director Chris Muhr explained why Google would be interested in the company: “Think about Google Adwords,” he said. “Type in a keyword in Google, say ‘bar’. You find a bar in your area…. [But Google] does not have direct contact with the business. The business does not come back [to Google] and say I want to attract customers via that search. Most of the time the customer does not convert from there into an actual customer.”

By the same token, Google offers Groupon something that it lacks: a more sustainable barrier to entry in the super crowded daily deal space. By pairing Groupon offers with Google Adwords results, Groupon would gain privileged access to one of the most potent distribution channels on the web, which would potentially help the company find answers to several of the key challenges that it is currently facing.

1. First, as Fortune pointed out in August, anyone can copy Groupon’s business model. Although Groupon has strong brand-name recognition and first-mover advantage, they’ve seen over 200 copycat sites appear in the United States alone, with an additional 500 sprouting up internationally. Several shrewd acquisitions have served them well in this regard, but specialized competition continues to spawn.
2. Groupon may believe that Google can help it meet the latent demand of small businesses who want to use Groupon. According to founder Andrew Mason in that same August interview, over 35,000 small businesses want to be featured on Groupon, and only one in eight will make the cut. The company has developed multiple deals per day in its largest cities in order to increase the number of merchants it is able serve, but as long as qualified companies are being left out in the cold, there will be an opportunity for competitors to serve the excess demand.
3. Lastly, there’s the hotly-debated issue of whether or not Groupon is good for small business owners. Although Groupon claims that 95% of all its merchants want to offer another promotion with them in the future, one study said that 42% would not make that decision again. On the NYTimes Boss Blog, there’s been a lively debate between business owners all month over whether or not the economics of such deep discounting makes sense. Certainly it’s up to each business owner to answer that question for themselves, but the perception of small companies going broke via Groupon is a damaging one, and one that the company must work to fix.

All of which lends credence to the idea that a Google-Groupon deal makes sense for the discount retailer in a way that a purely financial investment might not. Google offers Groupon more than just money, it offers a durable competitive advantage in the distribution of its service offering. In return, Google would deepen its presence in the local consumer search market and drastically enhance its ability to monetize its relationships with small businesses.

It’s this strange alchemy where 1+1 could equal 3 that makes strategic acquisitions potentially so powerful, and is why Google might be willing to pay close to $6B for Groupon, where financial buyers would be very unlikely to come close to arriving at such a valuation.

Image courtesy of smemon