False nostalgia for Google's IPO.

False nostalgia for Google's IPO.

False nostalgia for Google's IPO.

Moneybox
Commentary about business and finance.
July 27 2004 4:23 PM

Frugal Google

How it's upending the lousy IPO practices of the '90s.

Illustration by Mark Alan Stamaty

A few months ago, there was a sense that a hot Google IPO would mean we could party like it's 1999. The coming offering was hailed as a "gutsy retro attempt to recreate the happy-go-lucky glory days of the late 1990s," by Paul B. Farrell of CBS Marketwatch. As Time's Joshua Macht left Google's IPO-obsessed headquarters, "the sun was shining brightly, the fog had lifted and it was as if the whole of Silicon Valley cried out, 'We're baaaaack.' "

Now that the IPO is only weeks away, the Tech Bubble nostalgia has calmed down, and for good reason. Google may be an Internet company based in Silicon Valley. But its IPO won't be anything like a replay of the bubble heyday. If anything, it is a repudiation of the boom years. Google has rewritten the rules of IPOs in accordance with lessons learned from the 1990s.

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In the late '90s, most of the hottest dot-coms were money-losing cash-burners for whom the IPO was yet another round of venture funding. Not Google. In 2003, it had net income of $105.6 million. In the first six months of 2004 it netted another $143 million. The offering will raise an estimated $1.7 billion for Google, but it already has $548 million in cash.

In the dot-com era, IPOs were run as much for the benefit of the Wall Street underwriters as for the companies. Wall Street firms would set a price at which a company would sell shares to the broad investing public and distribute the shares. In practice, underwriters would dole out many shares to favored executives at client companies, or to hedge funds and mutual funds that threw a lot of trading business to the underwriters. By setting the price for dot-com stocks artificially low and by deciding who could get in on the IPO at the artificially low price, underwriters had a license to make their friends and clients rich in a matter of minutes, when frantic individual investors bid up the shares. (Before Eliot Spitzer came along, these conflicts of interest were known in Manhattan as "synergies.") In exchange for suppressing the offering price and thus depriving their client of needed capital, underwriters in most dot-com IPOs typically helped themselves to a fee totaling 7 percent of the offering.

But Google has largely cut out the underwriters. Its IPO is being structured as a Dutch auction. Any investor can submit a bid for as few as five shares. The underwriters will tally all the bids. They'll start at the top—$150, $200, whatever—and work their way down until all the shares are spoken for. That price then becomes the clearing price, which Google intends to use as the IPO price. There's no penalty for bidding high—if the clearing price is $140 and you bid $200 you'll pay $140. Those who bid under the clearing price get nothing.

Google's IPO price will thus be set naturally by all interested market participants, not artificially by underwriters. Google—and not well-connected investors—will receive the full benefit of investors' enthusiasm for the stock. To add insult to the injury of the chastened investment bankers, Google has decreed that it'll only pay a 3 percent underwriting fee.

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In other words, Google has inverted the process. Almost by definition, the buying enthusiasm will peak before the stock starts trading. And today, you and I have the same chance as Warren Buffett, or Ford CEO William Ford, or a hedge fund manager, of getting in on Google's IPO. For precisely that reason Warren Buffett and Bill Ford and hedge fund managers probably won't be bidding. They have no angle, no leg up on the rest of us chumps.

And so most professional investors will likely boycott the offering. This is one of the reasons that TheStreet.com's James Cramer, a brilliant commentator and trader (but not one given to irony), has already dubbed the Google deal a fiasco. As Cramer implies, giving the stiff-arm to the professional investors who comprise a significant majority of the market, and who constantly have money to put to work, isn't an intelligent long-term investor-relations strategy. Professional investors in effect become salesmen for a company's stock. Selling stock without them is almost like Coca-Cola deciding to eschew the wholesale market (McDonald's, Marriott, college dormitories) and focus exclusively on selling six-packs to individual customers.

Google's IPO ensures that individual investors are treated fairly, as was frequently not the case in the 1990s. But it won't ensure that they'll make money. In fact, Google explicitly warns those seeking a quick buck not to bother: "We caution you not to submit a bid in the auction process for our offering unless you are willing to take the risk that our stock price could decline significantly." In fact, because of the auction process, the individual investors who absolutely positively must have this stock on the day of its offering may very well be buying at the top. At least some things never change.