Search Yields Many Reasons to Avoid the Google IPO
As the former author of a stock-market pick-’em column (along with my colleague Jim Peltz), I’ve been getting a lot of inquiries from people lately about whether they should bid on the white-hot initial public offering for the Web search company Google Inc.
In truth, I’m a bit mystified that people are even asking this question. After all, this is the highest-profile IPO in years, for a company that has been relentlessly scrutinized by the experts and pronounced an earnings prodigy. The bidding, furthermore, will be conducted on terms designed to let the little guy in on the action. Therefore, if the issue is, “Should I invest?” the answer is crystal clear: of course not.
Now, before this judgment provokes the Google faithful to march on my office with torches blazing, allow me to say that it has nothing to do with the sterling qualities of the company’s service. I myself access Google dozens of times a day because I’ve found it the quickest and most reliable search page ever. I particularly admire the way the company is always rolling out new search functions without fanfare, as though not to deprive users of the thrill of discovery.
Did you know, for instance, that if you type a mathematical formula into the Google box, it will give you the solution? (This function works in octal, hexadecimal, binary and even Roman numerals.) Google also will return an area code’s geographical location; the make and model of a car based on its vehicle identification number; the phone number of a business you identify by name, city and state; and an airliner’s arrival and departure info or in-route progress based on the flight number.
I appreciate, too, the company’s stated determination to keep its search algorithm unpolluted by pay-for-placement deals or other revenue-enhancing ideas.
It’s equally hard not to be impressed by the company’s financial results. These were made public April 29, when Google filed a preliminary disclosure with the Securities and Exchange Commission in anticipation of an IPO within the next few months. In this filing, Google reported 2003 sales of nearly $1 billion (mostly from advertising placed discreetly in its search pages), yielding a profit of $106 million, and hinted that revenue and net income were on track to more than double this year.
The company reported about $455 million in cash on hand even before the IPO, which is designed to bring in $2.4 billion or so -- reinforcing the market’s perception that the IPO is driven not by the company’s need for capital but by a quirk of the securities laws.
The Google service’s lustrous quality and profitability, however, are scarcely the whole story when it comes to the IPO’s suitability for the small investor. Wall Street history is brimming with great companies that were lousy choices for investors -- and lousy companies that were, at least temporarily, great investments. What’s important are the prospects for making money on the stock in the short, medium and long term, and here the picture is cloudier.
Customarily, those prospects are judged according to the issuer’s future potential for profit growth, measured against the price at which the stock is selling at present. If today’s price already reflects optimistic expectations for the future -- let alone manic expectations -- it’s plainly less attractive than if the stock market were somehow overlooking the company’s great potential and thus undervaluing its shares. Investment heroes like Fidelity’s Peter Lynch beat the bushes for stocks in the latter category. The lambs led to slaughter in the dot-com crash had bought up the former.
So the fundamental question about Google is: How likely is it that its potential has been overlooked? Google’s financial results, part of the public domain for all of four weeks, must already rank among the most thoroughly parsed numbers in investment history. There can hardly be a single revenue stream that sneaked in under the analytical radar, except for any that might arise from services still in development -- and those are, necessarily, conjectural. Google may be a treasure, but it sure isn’t buried treasure.
Then there’s the unusual structure of the company’s planned IPO. It will be a “Dutch auction,” through which any investor may submit a bid for any number of shares. Once all the bids are in, the shares will be distributed more or less evenly among all successful bidders.
This differs from the traditional IPO, in which a group of Wall Street underwriters tries in advance to estimate the price that will clear most of the shares for sale. (If they guess too high, they’ll be stuck with a lot of overpriced inventory; too low, and the shares will be bid up by investors buying from the initial recipients, and the company will be ticked off that its advisors sold it cheap.)
It is now received wisdom that one way the average investor got ripped off during the high-tech bubble was through investment bankers’ handling of these conventional IPOs. The bankers bought themselves favors and business by funneling shares in the hottest offerings to their pals and most privileged clients, who bought at the low issue price and profited handsomely from the exuberant bidding that occurred once the shares hit the open market.
The Google auction taps into the small shareholder’s resentment at having had to watch this party from behind the velvet rope by trying to ensure that everyone gets an equal crack at the offering. The registration statement describes this as seeking “a fair process for our IPO that is inclusive of both small and large investors.”
Yet despite its abundant warnings that investors may not see much upside, the document may not have made sufficiently clear who will benefit the most from the auction system: Google itself and its original backers, including Silicon Valley venture firms.
If the auction works properly, there won’t be any difference between the issue price and the immediate post-issue, or “aftermarket,” price, as there is in many traditional IPOs -- the shares will be issued at the price the market demands.
That means that the spread traditionally pocketed by underwriters and their cronies will be pocketed instead by the company and its venture backers. The little guy wouldn’t be able to profit from the spread either, as IPO insiders used to do. In other words, the small investor will finally be allowed past the velvet rope, only to discover that there’s no more party.
The remaining questions about Google concern whether it is, as it believes itself to be, a special kind of enterprise. From the registration statement: “Google is not a conventional company. We do not intend to become one.” To this sentiment, expressed by co-founders Sergey Brin and Larry Page, one can only respond, in all sincerity: “Good luck.”
For the real world has a way of undermining such resolution, no matter how heartfelt. As the company acknowledges, Google faces strong competition from such well-heeled and experienced trench fighters as Microsoft Corp. and Yahoo Inc., both of which are polishing search technologies and business plans aimed squarely at Google’s parti-colored trademark. Google’s workforce, heretofore monastically devoted to improving the brand, may become distracted by the opportunities, not to say jealousies, that come with the exercising of stock options worth millions of dollars.
As challenges multiply, Google’s leadership troika (Brin, Page and Chief Executive Eric Schmidt), which is portrayed now as a wonderfully collegial team, may prove unwieldy and fractious. The unassailable voting majority that will vest with insiders after the offering may become less a guarantee of effective, visionary management and more of an impediment to continued success.
When I read in the registration statement of Google’s determination to enhance employee benefits over time, rather than pare them, I was gratified -- and also reminded that Intel Corp. once prided itself on never having had an employee layoff, right up until the moment that it started laying off employees. One sure thing about Google -- much surer than that it will succeed -- is that it will change.
This is not to say that Google’s stock price may not open in the stratosphere and continue on to the moon or beyond. It’s not unusual for favorites to win at Santa Anita, either. Google even may be that rare extraordinary performer that outpaces the greatest expectations. But stock investing is a game of educated wagering, and even the most foolhardy horse player knows that you can never make as much money by betting the favorites as you can by looking for the occasional long shots ready to come in.
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Golden State appears every Monday and Thursday. You can reach Michael Hiltzik at golden.state@latimes.com and read his previous columns at latimes.com/hiltzik.
