Paul Holmes 01 Jan 2005 // 12:00AM GMT
IPO fever is back.
Less than four years after the dot-com boom went bust, it looks like the irrational exuberance is back. And one company is responsible: Google, which announced earlier this year that it would be offering stock to the public for the first time. The fact that a mere 10 percent of the company’s stock is for sale notwithstanding, the IPO has generated an avalanche media attention and investor interest—including at least a half-dozen websites dedicated to scrutinizing every press release, news article, and rumor about the impending offer.
That’s the kind of excitement you can generate when you’re a profitable Internet company and your name has become accepted as a verb. (Despite the “Do You Yahoo?” advertising campaign, have you ever heard anyone say, “Let me Yahoo! it and see what comes up?)
But Google is taking a different—some would say contrary—approach to its offering, one that has professional investors outraged, or at the very least skeptical, and one that has the potential to impact the way investor relations works, should it be adopted by other companies coming to market. Most IR experts don’t expect that to happen, but they concede that Google is trying something new, something that will at the very least raise some interesting IR challenges for the company itself.
“Google may be an Internet company based in Silicon Valley,” says Daniel Gross, who writes the Moneybox column for Slate. “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.”
One obvious difference: in the late 90s, most of the hottest IPOs involved money-losing dot-com companies with no discernible income potential or business strategy, for whom an IPO was just a new way to raise venture funding. Google had net income of $105.6 million in 2003, and in the first six months of 2004 it earned another $143 million. It doesn’t need the cash, it has about $548 million on hand.
But more to the point, as Gross says: “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…. 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’s offering is structured as a Dutch auction. Any investor can submit a bid for as few as five shares. The underwriters will then start awarding shares based on the amount bid, starting with the highest and working their way down until all the shares are spoken for. When the last share is handed over, the price bid for it then becomes the clearing price—the price at which all the shares are sold. So if the clearing price is $140 and you bid $200, you pay $140, just like everyone else.
“Google’s IPO price will thus be set naturally by all interested market participants, not artificially by underwriters,” says Gross, approvingly. “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.”
Gross acknowledges that because they don’t have any advantage—there’s no inside track for cronies of the investment banks—and because there probably won’t be a big surge in the stock price after the auction is over (by definition, the price set by the auction will be the market’s judgment of the “right” price), institutional investors probably won’t participate.
That’s why James Cramer, columnist for RealMoney.com, says: “If you wanted to do everything you could to kill the Google deal, if you wanted to do everything you could to be sure that you generated the worst deal ever, you would do exactly what Google’s done.
“First, you buck the system, which had finally gotten a lot of the kinks out of it, and make sure that the thing’s done Dutch…. Second, you set the price at a level that is the most forbidding to the most people: north of $100…. Third, you talk about shareholder democracy but then you do the single most anti-democratic thing possible: issue two classes of stock. Fourth, you wait until the dog days of summer to do the deal when no one’s around anyway. Fifth, you show total contempt for all of the institutions that, like it or not, represent most of the buyers out there, especially now that you price the deal at $100 a share.”
Gross acknowledges that “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.”
Google acknowledges that the IPO is not going to provide anyone with a chance to turn a quick profit: “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,” says the company.
In some ways, both Gross and Cramer are wrong, investor relations experts say.
“It seems to me that both Gross and Cramer are missing a key point,” says Jeffrey Lloyd, managing director of the east coast operations of Los Angeles-based corporate and financial PR specialist Sitrick & Company. “The primary objective of an initial public offering is to maximize the amount of funds raised, while minimizing the costs involved, and it appears that Google has figured this out. Google is letting the market decide how much a share is worth, rather than the underwriters, and Google has placed a cap on how much it is willing to pay in underwriting fees.”
Or perhaps both commentators are right.
“From Google’s perspective, Gross is right,” says Bryan Armstrong, a partner at investor relations and corporate communications advisory firm Ashton Partners. “He points out that Google learned from its IPO predecessors that traditional IPOs leave money on the table because the deals are intentionally under-priced to create demand for the offering. This is money that would otherwise go to Google.
“On the other hand, from the investors’ perspective James Cramer is right. Dutch auction IPOs do not typically have the ‘first day pop’ that a traditional IPO has, for the aforementioned reason. Most everyone knows that traditional IPOs are under-priced, but few know by how much. This creates a first day ‘buzz’ that likely will not accompany a Dutch auction deal.”
So Google probably won’t leave as much money on the table as those companies that saw their share price rise dramatically immediately after an IPO, says Michael Claeys, executive vice president at Burson-Marsteller. “But the investor hoping for more upside right away will be disappointed because the winning bid price will probably be higher than the true market value at that point in time.”
There are differences “at the technical level and the conceptual level,” says. “Conceptually, they are trying to democratize the IPO by opening it up to an auction system instead of what some have considered a controlled system that favors institutional investors and, in some instances, friends of the underwriters. Technically, the process of conducting the auction is complex, inherently risky, and subject to tight standards. It will certainly not be as profitable for the traditional underwriter.”
It’s an approach that is geared to the retail investor, says Claeys. And it is difficult to gauge the likely level of institutional interest. “There has been a lot of grumbling about not having enough information. I think many institutions will hold back, let individuals drive up the price, and then wait for buying opportunities post-IPO when the price may start dropping to more attractive levels.”
From the communications standpoint, he says, promoting this more egalitarian alternative to traditional IPOs “has its appeal, but the details of how the auction will work complicate the story,” says Claeys. “I think it is premature to say the rules have been rewritten until we see how it goes. They are trying to transform the rules in ways that, at least in principle, address the areas that have been criticized in the past. The biggest risk is that too many investors will go in looking for a quick hit, expecting the dramatic post-IPO increases they have seen in the past, which had been generally unavailable to individual investors.”
That creates some specific communications challenges.
“By bypassing the institutional market, Google’s challenge will be to communicate the risks and opportunities to retail investors in a clear, consistent and timely manner,” says Lloyd. “These materials should communicate Google’s long-term strategy, along with the short-term risks, because the objective is to attract knowledgeable long-term investors, not short-term speculators.”
But so far, Google hasn’t delivered the information investors need, says Keith Mabee, president of Cleveland PR and IR firm Dix & Eaton. The company, he says, is “not being transparent enough about how its sees the business evolving in the future and how it intends to deliver on its value proposition over time. It is paramount to lay out the company’s strategic vision in enough detail to allow investors to appropriately assess whether their past performance is sustainable in the future against strong competitors like Yahoo.”
Chris Atkins, who heads the corporate practice at Ogilvy Public Relations, agrees: “The biggest obstacle is that most of the investors Google claims to be trying to attract don’t have a clue how an auction works. And frankly, the whole prospectus reads like the Communist Manifesto.”
On the registration document’s sixth page, founders Larry Page and Sergey Brin spell out their intentions in an “owner’s manual” for Google shareholders. They promise to emphasize long-term business over short-term results, for example. But while profits have been healthy and trending healthier, there are serious questions about the company’s long-term viability. Critics worry that the firm’s business model is one dimensional, with 80 percent of sales coming from the ads that appear alongside search results. Growth in that market is expected to slow in coming years.
The pre-IPO roadshow will present another challenge, says Armstrong. In a traditional offering, the investment banks can structure roadshows with investors who have either subscribed or expressed interest in the deal. But the Dutch auction approach makes that more challenging. “The marketing strategy becomes more difficult for investment banks because they have less control over which investors are allocated shares.
“Google will still go on a roadshow to meet with interested investors, but may not end up meeting with the investors that ultimately get shares in the auction process. As a result, Google will likely have to organize a post-deal roadshow to get in front of these shareholders.”
Then there’s the anti-democratic aspect of the deal. The company is creating a dual-class stock structure, which leaves Page and Brin with ultimate control. That seems to run counter to the democratic trend, which has seen investors push companies for equal voting rights and a single class of stock. Corporate governance experts say just over 10 percent of publicly traded companies have dual-class structures. (Many media companies have dual-class structures, claiming it helps preserve editorial integrity. Google sees search as an editorial product.)
Even so, Kenneth Froewiss, professor of finance at New York University’s Stern School of Business says the dual-class approach is anti-democratic. “It flies in the face of the one-share, one-vote idea.” He predicts: “The [valuation] discount tends to be a couple of percentage points.”
And finally, there have been other, highly visible, problems. Says Atkins: “When orchestrating an unorthodox IPO, try to avoid having your product disappear for several hours—as it did recently—due to a virus.”
But Lloyd says the company has an advantage in that many of the likely buyers are Internet users who are familiar with Google’s technology, its business model, and its long-term strategy.
“There are vast numbers of individuals who conduct their business on the Internet. They use Google in their everyday lives and can understand the power and the potential of Google’s business model. It would seem that these individuals would constitute a prime market for Google’s stock.”
There will also be challenges after the IPO, if the shareholder base is dominated by individuals rather than institutions.
“If the ownership is dominated by retail holders, it makes the IR job more difficult and more expensive,” says Claeys. Individual investors “are generally harder to reach and it costs multiples to communicate the same information to the holder of five shares as to the holder of five million. The ownership base will also be quite volatile. They are more susceptible to the rumors or theories or ambient advice that further promotes volatility and makes communications difficult.
“Almost certainly an early priority will be to shift ownership to a larger institutional base, and over time they may be tendering for odd lots just to simplify the IR communications process.”
So will it work?
“If success is defined by how high the stock price goes the first day of trading, then no, I don’t think it will be as successful as other IPOs this year,” says Armstrong. “On the other hand, Google will find it to be tremendously successful from the perspective of raising capital. And ultimately, raising capital is the reason why companies go public in the first place.”
So others might follow. “If Google is able to meet its fund-raising objectives, and is able to attract a stable stockholder base that is in for the long-haul, this could become a powerful IPO model,” says Lloyd.
But they won’t necessarily find it easy.
“If this turns out to be a huge success others may follow, but there will be a lot of resistance from the underwriters,” says Claeys. “Google was the big player in this space and could push for its way of doing this. Probably only another player with the same muscle—and the same broad based consumer
identification and popularity—could pull it off, and only if this one goes well. I don’t think this will replace the traditional IPO any time soon.”
Says Armstrong, “Companies that are interested in doing a Dutch auction deal will have to challenge the ‘old boys network,’ which is easier said than done. As a result, Dutch auctions are typically only selected by larger, well-known, companies. However, investment bankers have additional incentives to move forward with these deals, even if they are not initially as profitable, because there is an opportunity to generate huge fees in periphery areas like trading, M&A deals, and follow-on offerings.”
So predictions for the long-term impact of the deal on the investor relations are mixed.
“The only long-term implication I see with this deal,” says Armstrong, “is that Google has created a somewhat negative financial brand with the Street, which has been fueled by the media. Google is thought of as a somewhat rogue or unconventional large cap. In the large cap-investing world, which is dominated by more conservative, risk-averse investors, this could pose a few challenges. However, at the end of the day, Google will still have shareholders just like any other large cap. What will ultimately define how they are perceived is their investor relations strategy after the deal.”
Lloyd disagrees. “This IPO has profound implications for investor relations,” he says. “If Google is successful in attracting a broad, retail shareholder base, the IR professional will be called upon to devise new and creative communications programs to ensure that these shareholders, as well as potential new investors, receive accurate and complete information in a timely and consistent manner.”