Friday, August 13, 2004
Annals of corporate arrogance: Google
I love their product, and wear a Google Toolbar proudly at the top of my browser (5576 pop-up ads blocked as of this writing!). But judging from their actions in the run-up to Google's initial public stock offering, the guys who run the company are arrogant and immature, and that spells trouble for stockholders.
First, the "dutch auction" structure of the transaction seems to hurt the interests of both underwriters and large institutional investors. This is emotionally appealing because it eliminates the opportunity for "spinning" the IPO to favored clients of the investment banks. It is financially appealing because it cuts the commission paid to the underwriters and decreases the chance that the offering will surge in the first day, which always causes people to wonder whether the issuer left proceeds on the table, as it were.
Both of these advantages, though, are superficial. By taking away the opportunity of the underwriters to direct allocations of the stock, Google is also depriving them of their ability to build a base of large institutional investors with the financial capacity to drive the value of the stock up over many years. This is important to the success of the offering over the long-term. Why? Because the initial allocation of stock to, say, Fidelity, will determine whether they do the work to decide to buy more stock in the aftermarket. It is the building of institutional positions in the weeks and months after an IPO that makes that transaction a success. All the enthusiastic individuals in the world can't make up for ten or fifteen big mutual funds each deciding to buy hundreds of thousands of shares. But without assurances that they will receive a significant minimum allocation, many potential institutional investors may not invest the effort necessary to make a decision to build a position in the stock.
Similarly, by depriving investors of an early "pop" in the stock, Google is trading away long-term good feelings for proceeds today, and it risks establishing an early value for the stock that it cannot sustain. This is precisely the opposite of the decision allegedly made by the founder of another famous tech company, and therein lies a tale.
According to Wall Street lore, at the brink of the Microsoft IPO, Goldman, Sachs & Co. told Bill Gates that it could bring the company public at a particular post-offering valuation (which, if memory serves, was about $2 billion). According to this oral tradition, Gates deliberately cut the price of the offering to half of that proposed by his underwriters, precisely so that "everybody will make money off of Microsoft." That is, he knew that by leaving some proceeds "on the table" and by keeping the expectations for Microsoft, and therefore its valuation, relatively low, the company would be able to demonstrate the sustained success against those expectations that would drive the value of the company to the stratosphere over the next few years.
There is a difference, sometimes, between being short-term greedy and long-term greedy. Gates is the latter, and the Google founders, for all their "do no evil" mantra, are acting like the former.
Finally, it now looks like the Google founders have jumped the gun, which is securities lawyer jargon for marketing the deal during the "quiet period." The idea behind the prohibition on "gun jumping," which gives rise to the pre-IPO "quiet period," is that the marketing of the offering should be done only from the prospectus, which is incorporated in the issuer's registration statement filed with the Securities and Exchange Commission. The issuer has strict liability for the truth of statements made in the registration statement, so the SEC requires that all statements about the company made during the marketing of the deal be incorporated, one way or another, in the registration statement. So what do these guys do? They give an interview to Playboy! The talk on CNBC this morning is that that interview, which apparently contains inaccurate statements, will have to be incorporated into the Google prospectus. That's more than a little incompetent.
This offering may be a success, in that a lot of dumb money may pay a lot to buy this stock. But I doubt very much that Google's management has the maturity to build stockholder value over the long-term.
First, the "dutch auction" structure of the transaction seems to hurt the interests of both underwriters and large institutional investors. This is emotionally appealing because it eliminates the opportunity for "spinning" the IPO to favored clients of the investment banks. It is financially appealing because it cuts the commission paid to the underwriters and decreases the chance that the offering will surge in the first day, which always causes people to wonder whether the issuer left proceeds on the table, as it were.
Both of these advantages, though, are superficial. By taking away the opportunity of the underwriters to direct allocations of the stock, Google is also depriving them of their ability to build a base of large institutional investors with the financial capacity to drive the value of the stock up over many years. This is important to the success of the offering over the long-term. Why? Because the initial allocation of stock to, say, Fidelity, will determine whether they do the work to decide to buy more stock in the aftermarket. It is the building of institutional positions in the weeks and months after an IPO that makes that transaction a success. All the enthusiastic individuals in the world can't make up for ten or fifteen big mutual funds each deciding to buy hundreds of thousands of shares. But without assurances that they will receive a significant minimum allocation, many potential institutional investors may not invest the effort necessary to make a decision to build a position in the stock.
Similarly, by depriving investors of an early "pop" in the stock, Google is trading away long-term good feelings for proceeds today, and it risks establishing an early value for the stock that it cannot sustain. This is precisely the opposite of the decision allegedly made by the founder of another famous tech company, and therein lies a tale.
According to Wall Street lore, at the brink of the Microsoft IPO, Goldman, Sachs & Co. told Bill Gates that it could bring the company public at a particular post-offering valuation (which, if memory serves, was about $2 billion). According to this oral tradition, Gates deliberately cut the price of the offering to half of that proposed by his underwriters, precisely so that "everybody will make money off of Microsoft." That is, he knew that by leaving some proceeds "on the table" and by keeping the expectations for Microsoft, and therefore its valuation, relatively low, the company would be able to demonstrate the sustained success against those expectations that would drive the value of the company to the stratosphere over the next few years.
There is a difference, sometimes, between being short-term greedy and long-term greedy. Gates is the latter, and the Google founders, for all their "do no evil" mantra, are acting like the former.
Finally, it now looks like the Google founders have jumped the gun, which is securities lawyer jargon for marketing the deal during the "quiet period." The idea behind the prohibition on "gun jumping," which gives rise to the pre-IPO "quiet period," is that the marketing of the offering should be done only from the prospectus, which is incorporated in the issuer's registration statement filed with the Securities and Exchange Commission. The issuer has strict liability for the truth of statements made in the registration statement, so the SEC requires that all statements about the company made during the marketing of the deal be incorporated, one way or another, in the registration statement. So what do these guys do? They give an interview to Playboy! The talk on CNBC this morning is that that interview, which apparently contains inaccurate statements, will have to be incorporated into the Google prospectus. That's more than a little incompetent.
This offering may be a success, in that a lot of dumb money may pay a lot to buy this stock. But I doubt very much that Google's management has the maturity to build stockholder value over the long-term.
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