Three weeks after a limited public offering engineered a short-lived 40% pop, Groupon (NAS: GRPN) closed below its $20 IPO price last Wednesday and remains there as of this writing. Thus, the company thought to be worth $30 billion in market value in June is now worth $11 billion.

That's $19 billion in market value gone. Poof. Up in smoke. Off to Never Never Land. Buried beneath Davey Jones' Locker. Will it resurface? Perhaps, but I'm making a CAPScall to the contrary. I believe that Groupon is the next Vonage (NYS: VG) and will underperform just as badly, because it lacks a clear and compelling competitive advantage.

More groupies means more group buying ...
I'll get into the numbers in a minute. First, let's talk about how the business works. Groupon has subscribers (i.e., average Janes and Joes who get a daily email) and customers (i.e., those who've bought at least one Groupon). Growth in each category has been amazing.

Groupon's subscriber list is up more than 227 times over the past two years -- from 627,000 to nearly 143 million as of Sept. 30. The cumulative customer count is up 192 times over the same period. Gains have accelerated throughout, right up until the most recent quarter:

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Groupons are also getting increasingly popular. More than 33 million were sold in the latest quarter, resulting in a record $1.16 billion in billings -- i.e., the gross dollars collected before payouts and other expenses. All signs point to outrageous demand for bulk buying of big discounts.

Finally, consider that Groupon is just as successful today at converting subscribers into customers as it was in its opening months. Between 23% and 24% of those that receive pitches ultimately buy. Better still, today's customers tend to spend twice as much as Groupon's early loyalists.

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... But it doesn't mean more profits
So what's the problem? First, billings growth hasn't equaled earnings growth for some time now. It did in the beginning, though. Groupon was profitable in three of its first four quarters. All that changed when the calendar flipped to June 1, 2010. Groupon hasn't booked an operating profit since.

Analysts will tell you that heavy investments in growth are to blame for Groupon's lack of operating profitability, but I think competition has much more to do with it. Regulars now buy about one Groupon per quarter, down roughly 50% from the fall of 2009.

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Alternatives are cutting into Groupon's sales, LivingSocial notably. Others include Google's (NAS: GOOG) Offers service and a variety of just-in-time pitches that appear when you're near a store. Foursquare is particularly adept at delivering these sorts of offers thanks to its partnership with American Express (NYS: AXP) .

The beauty, and danger, of the stiff-arm strategy
Higher billings have thus far allowed Groupon to keep growing even as rivals nibble at its franchise. Operating losses have shrunk over the past year while cash has continued to flow. Each Groupon sold generated $2.17 in cash in Q3, down slightly from $2.36 each in last year's third quarter yet still more than enough to cover the company's meager capital expenditures.

Cash generation may explain why Google originally bid $6 billion for the business. Or why secondary market enthusiasm pushed the company's valuation to $30 billion in June. Or why, the next month, CNBC reported that LivingSocial was seeking underwriters to raise as much as $1 billion in an IPO. Group buying was -- and arguably still is -- the Next Big Thing.

Even so, Groupon has been saying for months it wouldn't use the cash raised in a public offering. All proceeds were to be placed in a money market account alongside the $244 million in net cash and short-term investments held as of Sept. 30. (Groupon is debt-free.)

So that's good news. The bad? A large portion of Groupon's cash is borrowed, held back from merchants until the company is contractually obligated to release it. Here's the specific language, taken from page 15 of the revised prospectus:

"Our merchant arrangements are generally structured such that we collect cash up front when our customers purchase Groupons and make payments to our merchants at a subsequent date. In North America, we typically pay our merchants in installments within sixty days after the Groupon is sold. In our International segment, merchants are not paid until the customer redeems the Groupon." [Emphasis added.]

There's nothing sinister or untoward about this model. Amazon.com (NAS: AMZN) has made a great living by getting customers to pay for goods upfront, kicking payments to suppliers only after orders are in hand. The staggered timing helps to produce billions in cash flow. Groupon's model is similar.

Yet there are notable differences, too. Time arbitrage accounts for about two-thirds of Amazon's cash from operations. Groupon's largest source of cash is per "accrued merchant payables," to use the company's specific accounting terms.

Groupon has collected $315 million in cash over the past nine months alone by keeping billings close at hand while delaying payments to merchants. The result? More than $129 million in operating cash flow for investing in infrastructure and other growth initiatives.

How this ends badly
Investors can hardly be blamed for getting excited by the big numbers. What troubles me is that the gains are dependent on Groupon's ability to negotiate and maintain favorable contracts in the face of extreme competition. How reasonable is it to expect merchants to wait at least 60 days to get paid if LivingSocial, or Google, or the advertising team at the local newspaper offers better terms? Does Groupon still maintain a brand advantage at that point? I'd say no.

If I'm right, cash will stop flowing as abundantly as it has. The balance sheet will get weaker. Management will raise funds from the outside, diluting existing investors. And profits will remain as elusive as ever. That's why I'm calling for this stock to underperform in my CAPS portfolio.

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At the time this article was published Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He owned shares of Google at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Google+ or Twitter, where he goes by @milehighfool. You can also get his insights delivered directly to your RSS reader.The Motley Fool owns shares of Google. Motley Fool newsletter services have recommended buying shares of Google, McDonald's, and Amazon.com and creating a write covered strangle position in American Express. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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