Monday, 25 July 2016

Rocket Internet (RKET GY) ... And So It Goes

Monday 25th July 2016

Groupon (GRPN US, mkt cap $2.2bn) acquired CityDeal Europe GmbH in May 2010. CityDeal was owned and founded by Oliver Samwer, Marc Samwer, and Alexander Samwer; the Samwer brothers. They are also the founders of Rocket Internet (RKET GY, mkt cap €2.9bn). CityDeal was effectively a replica of Groupon, although principally focused on the German market.
We began our international operations in May 2010 with the acquisition of CityDeal Europe GmbH, or CityDeal, which was founded by Oliver Samwer and Marc Samwer. Since the CityDeal acquisition, Messrs. Samwer have served as consultants and been extensively involved in the development and operations of our International segment. 
Source: Groupon 2012 10-K filing 
GRPN's 2012 10-K filing suggests that it paid up to $204 million for CityDeal in May 2010, five months after the business was launched in January 2010. Yes months!
In May 2010, we acquired CityDeal, a European‑based collective buying power business launched in January 2010 that provided daily deals and online marketing services substantially similar to the Company. As part of the overall consideration paid, we were obligated to issue additional shares of our common stock in December 2010 due to the achievement of financial and performance earn-out targets. We recorded a liability on our consolidated balance sheet as of the original acquisition date for this consideration and subsequently remeasured the liability on a periodic basis until final settlement. As a result of this remeasurement, we recorded a total charge of $204.2 million in acquisition‑related expenses in 2010, which was partially offset by other nominal acquisition‑related items.
Source: Groupon 2012 10-K filing
GRPN has been something of a disappointment. Having floated at around $20 a share in late 2011, its share price is now some 82% lower at $3.76/shr. Whether the CityDeal acquisition created value or destroyed value for GRPN is uncertain. What is more clear cut is the destruction brought about by the other business which the Samwer brothers sold to GRPN; E-Commerce King Limited.

E-Commerce King Limited

According to GRPN's 2012 10-K filing, in January 2011, GRPN acquired 40% of the ordinary share capital of E-Commerce King Limited in exchange for $4.0 Million.
Equity Investment in E-Commerce King Limited
In January 2011, the Company acquired 40.0% of the ordinary shares of E-Commerce King Limited (“E-Commerce”), a company organized under the laws of the British Virgin Islands, in exchange for $4.0 million. The Company entered into the joint venture along with Rocket Asia GmbH & Co. KG (“Rocket Asia”), an entity controlled by former CityDeal shareholders Oliver Samwer, Marc Samwer and Alexander Samwer (the “Samwers”). Rocket Asia acquired 10.0% of the ordinary shares in E-Commerce. E-Commerce subsequently established a wholly-owned foreign enterprise that created a domestic operating company headquartered in Beijing, China (“”), which operates a group-buying site offering discounts for products and services to individual consumers and businesses via internet websites and social and interactive media. began offering daily deals in March 2011 in Beijing and Shanghai with expansion to other major cities in China to follow.
Source: Groupon 2012 10-K filing
This would suggest a $10 Million valuation for the entire issued ordinary share capital. GRPN's stake in E-Commerce King, was with a joint venture with Rocket Asia GmbH & Co. KG, which was controlled by the Samwer brothers. Rocket Asia acquired 10% of the ordinary share capital in E-Commerce King.

GRPN went on to highlight that around six months later, GRPN acquired a further stake in E-Commerce King, purchasing its increased stake in E-Commerce King from the Samwer brothers', Rocket Asia, for $45.2 Million. GRPN also injected a further $26.7 Million into the E-Commerce business during the same year.
On July 31, 2011, the Company entered into an agreement to purchase additional interests in E-Commerce for a purchase price of $45.2 million from Rocket Asia consisting of 2,908,856 shares of non-voting common stock. See Note 15 “ Related Parties ”. The investment increased the Company's ownership from 40.0% to 49.0%. In addition, the Company made various cash investments for an aggregate amount of $26.7  million in the year ended December 31, 2011. At the same time, the remaining investors made additional proportionate investments that resulted in no change to the Company's ownership percentage in E-Commerce.
Source: Groupon 2012 10-K filing
GRPN's stake rose from 40% to 49%, suggesting that the $45.2 Million purchase valued E-Commerce King at c. $502 Million. That's an impressive 50x increase in valuation in a matter of six months. Although somehow the remaining investors made proportionate investments which resulted in no change to GRPN's ownership percentage in E-Commerce King.

Incidentally, E-Commerce King appears to have racked up losses of $26.5 Million during its first year of trading.
The Company recorded its share of the loss of E-Commerce in the amount of $26.5 million within “Equity-method investment activity, net of tax” in the consolidated statement of operations for the year ended December 31, 2011.
Source: Groupon 2012 10-K filing
A few observations:

  • Incredible uplift in valuations in short order. 
  • As astonishing losses in short order. 
  • The Samwer brothers didn't stick around. 

Skip forward a year

During 2011 and 2012, GRPN made additional cash investments into E-Commerce King of $32.9 Million, increasing its stake to 49.8% along the way. Then in June 2012, E-Commerce King was absorbed by Life Media Limited (F-tuan). In return for GRPN's 49.8% stake in E-Commerce King and a further $25 Million in cash, GRPN received a 19% interest in F-tuan.
In June 2012, Life Media Limited ("F-tuan"), an exempted company incorporated under the laws of the Cayman Islands with operations in China, acquired E-Commerce. In exchange for its 49.8% interest in E-Commerce and an additional $25.0 million of cash consideration, the Company received a 19% interest in F-tuan in the form of common and Series E preferred shares. The Company paid $5.0 million of the cash consideration on June 25, 2012 and the remaining amount was paid on July 2, 2012.
Source: Groupon 2013 10-K filing
However, GRPN's stake in E-Commerce King was seemingly valued at $128.1 Million when it was transferred to the new entity, F-tuan. Then this value was impaired by $50.6 Million to $77.5 Million by December 31, 2012. This was c. 85% lower than the heady times when it bought an additional 9% for $45.2 Million from the Samwer brothers at an implied valuation of c. $502 Million, just 18 months earlier.  
Cost Method Investment in Life Media Limited (F-tuan)
The investment in F-tuan is accounted for using the cost method of accounting because the Company does not have the ability to exercise significant influence. Accordingly, the investment is adjusted only for other-than-temporary declines in fair value, certain distributions and additional investments. The $77.5 million carrying amount of the investment represents the $128.1 million fair value on the date the Company obtained it less the $50.6 million impairment discussed below. The estimated fair value of the investment as of December 31, 2012 was $77.5 million.
Source: Groupon 2013 10-K filing

Skip forward another year

By 2013, GRPN's full investment in F-tuan was written down to ZERO!
Investments in E-Commerce and Life Media (F-Tuan)
In June 2012, Life Media Limited ("F-tuan"), an entity with operations in China, acquired the Company's 49.8% interest in E-Commerce King Limited ("E-Commerce"), an entity with operations in China. In exchange for its interest in E-Commerce and an additional $25.0 million of cash consideration, the Company received a 19.1% interest in F-tuan in the form of common and Series E preferred shares. The Company recognized a non-operating gain of $56.0 million as a result of the transaction, which is included within "Other expense, net" on the consolidated statement of operations for the year ended December 31, 2012. The gain represented the excess of the fair value of the Company's investments in F-tuan over the carrying value of its E-Commerce investment as of the date of the transaction and the $25.0 million of cash consideration.
In August 2013, the Company entered into an exchange transaction with F-tuan whereby it received newly issued shares of Series F preferred stock in exchange for all shares of F-tuan common stock previously held by the Company and $8.0 million of cash consideration, which was paid in two installments of $6.5 million and $1.5 million in August and October 2013, respectively. The transaction was recorded at cost. The Company’s investments in F-tuan following this transaction are in the form of Series E and Series F preferred shares. Those preferred shares rank pari passu with certain other classes of F-tuan’s outstanding preferred stock and have an aggregate liquidation preference of $85.5 million. The Company’s voting interest in F-tuan remained 19.1% after the transaction. 
The Company's investments in the Series E and Series F preferred shares of F-tuan are classified as available-for-sale securities because the investee's Memorandum of Association provides for redemption of the preferred shares at the Company's option beginning in October 2017. The Company's investment in the common shares of F-tuan, which were held prior to the August 2013 exchange transaction, was accounted for using the cost method of accounting because the Company did not have the ability to exercise significant influence over the operating and financial policies of the investee. As discussed below, the Company's investments in F-tuan were written down to zero through an other-than-temporary impairment charge as of December 31, 2013, and continue to have an estimated fair value of zero as of December 31, 2014.
Source: Groupon 2014 10-K filing
That's some ride from a $10 Million valuation in January 2011, to an implied $502 Million valuation six months later, and all the way back down to ZERO within a few years.

This is precisely what I expect will happen to almost if not all of Rocket's "proven winners". And for that reason I am short Rocket.

Now ... how about those Kinnevik write downs, huh?
Hint: FT Alphaville Markets Live: Friday, 22nd July, 2016

Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog. 


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