Wall Street May Have Taken Google to School
Google Inc.'s unorthodox stock offering Wednesday may have taught Wall Street a lesson -- just not the one that was intended.
The company’s announcement of a lower-than-expected price for its shares raised fresh doubts about the auction process that has been touted as a fairer alternative to the way Wall Street long has sold new stocks.
For major investment banks that reap rich benefits from traditional underwriting practices, the lesson of Google’s struggle may be that their franchise is safe.
Bankers “didn’t want this to succeed,” said Kent Womack, a finance professor at Dartmouth College in Hanover, N.H., and a longtime critic of conventional stock underwriting practices.
Others said the problem wasn’t Wall Street but inherent problems in the complexity of the auction process chosen by Google’s founders.
“I think they made it a lot harder on themselves,” said Tom Taulli, co-founder of CurrentOfferings.com, a Newport Beach-based research firm that analyzes new stock offerings. “If I were a CEO going public, I would want to use the traditional approach.”
To be sure, it remains to be seen how the company’s stock will fare once it begins trading today on Nasdaq.
The company and some of its insiders late Wednesday sold a total of 19.6 million shares at $85 each, down from the range of $108 to $135 a share originally estimated by Google.
Traditionally, investment bankers determine the price and terms of an initial public stock offering, in consultation with the company and with interested large investors. For their work, bankers often earn fees worth as much as 7% of the money raised.
Google said it wanted to democratize the process by putting small investors on the same plane as the biggest investors and taking away Wall Street’s near-absolute pricing authority -- in the process slashing the fees the bankers would earn. So it chose to hold a version of the so-called Dutch auction.
Under the little-used system, the initial price of a stock is set by the marketplace: All investors are invited to bid and the bids are tallied by price and number of shares sought. The stock is priced at the highest level that still allows all shares to be sold.
Google and its insiders had hoped to sell as many as 25.7 million shares in the offering. If the price had been at $135 a share, the top of the initial estimated range, the total raised would have been nearly $3.5 billion.
Instead, apparently facing much weaker-than-expected demand, the company was forced to discount the price, insiders decided to sell fewer shares, and the deal raised a total of $1.67 billion.
Some proponents of the auction system said Wednesday that the 28 brokerage and investment banking firms picked to take orders for Google stock had little incentive to drum up demand, or even explain the auction process to their clients.
Bankers “thought, ‘If we let the door open with this, our margins are going to be cut in half’ ” in the long run, if the auction process caught on with more companies, Womack said.
Major brokerage firms involved in the Google offering, led by Morgan Stanley and Credit Suisse First Boston, either declined to comment Wednesday or did not make representatives available to comment.
But Taulli, of CurrentOfferings.com, said he doubted that the underwriters would want the Google stock sale to be a flop because it would hurt their own reputations.
“You’re only as good as your last deal,” he said. The bankers “probably regret being a part of this deal now, but I would bet they were doing everything to make it a success.”
Other analysts said the Google deal was rife with problems, including its timing -- in mid-August, when many investors are vacationing. Some money managers wondered why the company couldn’t wait until September.
Some also said that because the auction idea was innately complicated, many large and small investors alike were unwilling to take the time needed to register for the sale and decide how much to bid.
“From the bidder’s point of view, it’s got to be a very unsatisfying auction process,” said David McAdams, professor of applied economics at MIT Sloan School of Management in Cambridge, Mass. “People are very confused.”
Barry Ritholtz, market strategist at brokerage firm Maxim Group in New York, said Google’s co-founders, Sergey Brin and Larry Page, may have overestimated their ability to dictate to Wall Street and to investors.
“I think they thought, ‘We figured out the algorithms of Internet search -- now let’s figure out the algorithms of Wall Street,’ ” Ritholtz said. “Their reach exceeded their grasp.”
Still, he said, “I think what they’ve tried to do is admirable” in terms of opening the stock sale up to average investors.
Even if the company’s shares sold for less than Google had hoped, the auction process did succeed on one level: The investment bankers weren’t able to simply allocate the shares to their favored clients, at the expense of investors who may have been willing to pay more.
During the technology-stock boom of the late 1990s, bankers were accused of pricing hot new stock offerings far below what the market would bear, and issuing the shares only to their best clients.
The low offering prices guaranteed that the stocks would soar on their first trading day as average investors piled in.
“ ‘Rotten to the core’ is not too strong a term” for the traditional underwriting process, said Meir Statman, a finance professor at Santa Clara University.
Google’s attempt to champion a potentially fairer system “is all for the good,” he said.
Despite Google’s struggle, “I’m sure this is the wave of the future,” said Dartmouth’s Womack, referring to the auction process. “It’s just a question of how soon the future is.”