more on "Why I won't be a Google IPO Investor

[Dave Farber <dave () farber net>]

Delivered-To: dfarber+ () ux13 sp cs cmu edu
Date: Sat, 01 May 2004 10:15:49 -0400
From: Seth Finkelstein <sethf () sethf com>
Subject: Re: [IP] "Why I won't be a Google IPO Investor
To: Dave Farber <dave () farber net>

FYI: http://www.venturpreneur.com/weblogs/archives/000362.ht

Gordon Smith
The Google Auction  April 30, 2004

Much of the talk about Google's IPO has revolved around the
distribution method. Not since J.P. Morgan has the method of floating
shares attracted so much attention. Of course, Google is not inventing
the Dutch auction (see Hambrecht's website for more on that), but it
is providing some new exposure to the idea. The auction is
painstakingly described in the prospectus, so if you are a junkie for
this stuff, read that. You might also be interested in Hambrecht's
flash presentation that illustrates the auction process. This post
will target some of the highlights.

Qualification. Before potential investors are allowed to bid for
Google's shares, the investors must be qualified by the
underwriters. As part of this process, the potential investor must
access "an electronic form of this prospectus, including the
transcript of the presentation by our management team that will be
contained in this prospectus." The prospectus access requirement
merely satisfies the SEC's delivery rules, but I am intrigued by the
transcript. It sounds like an electronic road show (undoubtedly
without some of the more outlandish statements, which can only lead to
trouble with the SEC). Whether anyone actually reads the prospectus,
well, that's doubtful. Many people will read a little bit, I assume,
but most prospectuses are pretty dull. (Actually, this one is quite a
bit more interesting than most.) By the way, prepare right now for all
of the stories about deserving and eager potential investors who don't
qualify to buy shares. If you need a history lesson on this, go back
and read some stories about Red Hat's IPO.

Bidding. Potential investors submit bids, but this isn't like
eBay. You can't see what other people are bidding. Google cautions
against speculative bidding, though the whole enterprise is
speculative. The most interesting part of the process is the
interaction of bids and offers. The company will not fix the number of
shares in the offering until it reviews all of the bids.

      As part of this auction process, we are attempting to assess the
      market demand for our Class A common stock and to set the size
      of the offering and the initial public offering price to meet
      that demand. Buyers hoping to capture profits shortly after our
      Class A common stock begins trading may be disappointed.  During
      the bidding process, we and our underwriters will monitor the
      master order book to evaluate the demand that exists for our
      initial public offering. Based on this information and other
      factors, we and our underwriters may revise the public offering
      price range for our initial public offering as described on the
      cover of this prospectus. In addition, we and the selling
      stockholders may decide to change the number of shares of Class
      A common stock offered through this prospectus. It is very
      likely that the number of shares offered by the selling
      stockholders will increase if the price range increases. In an
      auction process, this could result in downward pressure on the
      price. You should be aware that we have the ability to make
      multiple such revisions up until closing of the auction and
      pricing of the offering.


Pricing. According to the prospectus, the company's goal is to set an
auction clearing price, which they describe as "the highest price at
which all of the shares offered ... may be sold to potential
investors, based on bids in the master order book that have not been
withdrawn or rejected at the time we and our underwriters close the
bidding for our auction."  The company does not commit to fix the
price at that level, but leaves open the possibility of setting a
price below the clearing price. The decision will be influenced by
factors such as the projected volatility of the post-IPO price, the
prices bid by professional investors, and their assessment of the
company's value. In other words, if the retail investors get out of
hand, we might reign them in. This is a standard reservation in these
Dutch auctions, and I would be interested to learn whether the issuers
and underwriters actually follow through on the threat. Rumor has it
that Hambrecht has priced several IPOs below the clearing price
(notably Andover.net), but I couldn't find any reliable information on
this practice. Perhaps it should go without saying, but this IPO will
make for good theater.

Allocating. In allocating the shares among successful bidders, the
company said that it will use one of two methods: pro rata allocation
or maximum share allocation. The former gives all successul bidders
the same percentage of their total bid, while the latter gives small
bidders the total number of shares on which they bid and large bidders
only a percentage.  No matter which method is used, "The allocation
process will not give any preference to successful bids based on the
extent to which the bid price per share exceeds the initial public
offering price."

Bottom line. One can read the auction in a couple of ways. While not
unique, it certainly is unusual, and it has been viewed as a method of
striking out against traditional underwritings. Early reports suggest
that Google negotiated an underwriting fee of 3%, much less than the
industry standard of 7%. Kudos to the company for that. Also, rumor
has it that Goldman Sachs lost out on the chance to underwrite the
offering when it expressed qualms about the auction format. (I'll bet
the partner responsible for that gaffe feels pretty stupid right now.)
So if you like the idea of tweaking investment bankers (and it's hard not
to like this idea), you should have some warm feelings about the auction.

My more cynical side sees trouble, however, because auctions are
typically associated with more volatile offerings, and Google has all
of the markings of an offering with retail overreaction. Also, as I
pointed out yesterday, the auction fits my hypothesis that the company
is seeking a more direct line to retail investors because the
professional investors would price the deal more modestly.

Let's review: (1) the founders implement a dual-class capital
structure to ensure that they have complete control; (2) they sell
directly to retail investors; and (3) they "encourage" (read: allow)
the venture capitalists to become selling stockholders. I suppose
potential investors could just trust them to have good motives, but my
reading is that the signals point in the direction of an unhappy
ending for IPO investors.

Posted by Gordon at April 30, 2004 10:09 AM | TrackBack  Comments


--
Seth Finkelstein  Consulting Programmer  sethf () sethf com  http://sethf.com
Interview: http://grep.law.harvard.edu/article.pl?sid=03/12/16/0526234
Seth Finkelstein's Infothought blog - http://sethf.com/infothought/blog/ 

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