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Maintaining Optimism in the Face of Reality. Occasional observations on the state of the world, society, business and politics. Usually anchored by facts, always augmented by opinion.


Google's Internet Irrationality Redux Hits a Snag  | e-mail post

Pete Seeger's last line from the wonderful folk standard, "Where Have All The Flowers Gone" is a cynic's koan, "When will they ever learn?" It's easy to be cynical in a world where you see people make the same mistakes, en masse, again and again.

I thought I saw the dot-com idiocy of a few years back happening again a few weeks ago, when Google priced out their IPO in the $108-$135 per share range. An offering in this range would value Google at around $36 billion dollars. To put this in perspective, look at some companies valued in $30-$40 billion range. Now, while Yahoo is in that list, it stands rather alone compared to the likes of Walgreens, Target, McDonalds, Gillette and similar well-established and expansive organizations.

One thing worth noting about the comparison to Yahoo: despite the Google buzz (it is, admittedly, the #1 search engine out there, with a bullet, at a 49% share), Yahoo generates about 150% more revenue and about 200% more profit than Google. [John Battelle's Searchblog provides access to an Excel spreadsheet of Google's financials. Here are Yahoo's fins.] Also, Yahoo will end up owning a bit more than 5% of Google after the IPO, so you really should credit Yahoo for that asset as well.

Also, give their prospectus a read for some of their risks. They have a lot, some of which reflect a broader risk of management competence, in my opinion. This is a company that is apparently either so incompetent, megalomaniacal, or just out of control that it neglected to consistently register all of its share sales and option grants with securities regulators. Over 1,000 times. Over a three year period. For over 23 million shares and 5 million options. If a company can't even handle that kind of blocking and tackling...well, yikes!

As an aside, does anybody know who Google's CFO is? He's a guy named George Reyes, but you never really hear about him. I don't know if he's just emasculated within the company, or if there is something more to it, but my experience is that CFOs are pretty good at keeping a company under control in general, and usually the whole capitalization process kind of falls to them as well. If Reyes can't even control his own bailiwick, who is actually maintaining any sort of internal controls?

Speaking of control, that's another fun thing about Google, the control of the company never leaves the founders hands, except under some fairly extreme circumstances. Google puts it charitably in their prospectus: "The concentration of our capital stock ownership with our founders, executive officers, employees, and our directors and their affiliates will limit your ability to influence corporate matters." In fact, they are issuing Class A shares in their IPO, yet all current shareholders will convert to Class B shares. Class B shares have 10 times the voting power of Class A shares. Oh, and Class B shares pretty much instantly convert to Class A if they leave the hands of their current owners.

Each of the two founders will end up with over 38 million shares of Class B stock. That is each of the founders will have about 16 times the voting power of the entire stock offered in the IPO. In fact, when you start to do the math on things, it is pretty difficult for the founders to ever lose control of the company short of the company issuing massive amounts of stock (about 40 times the number of shares coming out of the IPO).

As long as I'm digressing, another side note: with almost 5 million Class B shares post-IPO, Yahoo alone will have about twice the voting power of all public shareholders as a class. All of this flies in the face of good corporate governance. I'm doubting that CalPERS will be investing (Google doesn't use fair value accounting for their stock options either, another governance bugaboo.) I guess the "don't be evil" mantra doesn't apply to how they plan to treat shareholders.

Of course, the folks at Google are no idiots, they don't care about CalPERS even if it is the largest institutional investor in the U.S.. The plan was to have the offering priced by way of an auction, rather than by investment bankers, as would be the traditional practice. I remember reading a few years back that one of the interesting, yet counterintuitive, things about online auctioneer eBay was that in the auction format, sellers paid more than they might have otherwise paid as a quoted price. That is, they wouldn't buy the lamp if it were priced at $80, but they might well end up winning the auction for $100. Even more amazing was that they seemed happier about it.

In the case of the Google auction, the approach is even more loaded in their favor by using a sealed-bid auction. That is, a bidder submits their bid without any idea of market demand. Bidders are given the comfort of knowing that if they bid higher than the lowest price at which all orders are filled, their order will be filled at that lower price. While auctions of this sort favor savvy investors, one of Google's claims has been that a benefit of the auction process will be bringing in more individual investors. How nice they are opening the market to the less savvy. W.R. Hambrecht & Co provides an overview of the Dutch auction process. It's funny that even in their example, the institutional investor's order doesn't get filled because the price bid was too low.

Paul Farrell over at CBS Marketwatch had some interesting commentary about the irrational investor behavior Google was banking on back in May.

For my money, Google is just too cute for their own good. Just look their prospectus. Their filings indicate they plan to raise e (2.718281828) billion dollars. They couldn't just say "approximately 2.7 billion dollars" or something similar. No, they needed to be cute. Just like they plan to "not be evil." Again, this would be really cute if this was a mock prospectus developed by a twelve year old for some special school project, but this is supposedly a real company.

Thankfully, there is apparently a growing backlash against Google's IPO. [Reuters via Yahoo] Dan Gilmour from the San Jose Mercury News wrote about why he wouldn't bid on Google's shares. Of course, this is on top of the problems with their illegally sold shares that will potentially further dilute things or end up costing Google a boatload of cash to clean up as well as Google's slowing revenue growth and the slowing growth of paid search advertising, which accounts for the lion's share of Google's revenues, and of course, just their problems with their IPO auction process. Another article this morning observes that the "everyman investor" just isn't too interested, and reports an analyst's suggestion that the market range is probably more like $90-$96/share.

Having read this, if you still want to bid on Google's shares, be my guest. Knock yourself out, I'll take my chances in the aftermarket. If you want to get yourself jazzed up about it, you might want to look at the investor presentation, rather than the prospectus, it's a little more fun, and doesn't spend so much time discussing such pedestrian topics as risk or detailed financials.

Where have all the rational investors gone? Not to Google's IPO, apparently. Maybe people are learning.

OK, Rant off. This has just been bugging me for months now.

e-mail post | Link Cosmos | [Permalink]  |  | Tuesday, August 10, 2004
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