In search of fairer floats

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July 24, 2004

WOULDN'T it be nice to be sitting on some Microsoft shares, with Bill Gates buying back $30 billion of stock over the next four years, particularly if you bought them before the dotcom boom. Too bad.

Well what about Google? The dotcom's initial public offering (IPO), which is tipped for August or September, is expected to be the hottest thing since Wall Street's technology bubble burst in 2000.

If you use the internet, it's odds on you know and use Google. It's the world's dominant search engine and a wonder of the age.

To google (now meaning to search on the net) and googling are going into the language. Very flattering, and commercially very valuable. Actually, it worries Google. In its form S-1 prospectus filed with the US Securities & Exchange Commission in April, the company says it fears it could lose its trademark rights to one of the world's best-known brands if google becomes synonymous with search, allowing its rivals to freely use it.

This is just one of the 41 commercial risks listed in Google's prospectus -- which starts with "We face significant competition from Microsoft and Yahoo" -- that have to be taken into account when trying to decide what Google is worth.

Google's worth is not only preoccupying Wall Street advisers and investors, but has generated a great volume of argument on the web itself, which can of course be tracked by using Google. One of the first into the fray was Australian economist John Quiggin, described on his own website as "more intelligent than Britney Spears".

A popular market guess of the value of Google's equity is $US20 billion ($28 billion) to $US25 billion, with more recent estimates of $US30 billion or more. Quiggin, who is in fact quite bright, said he couldn't draw a plausible earnings path that would yield a present value of $US25 billion at any reasonable discount rate.

A prominent US economist, Brad DeLong, agreed. He calculated that to justify a valuation of even $US20 billion, Google would need to grow to approximately 10 times its current profitability and then maintain its market share and margins indefinitely. "High sustained profits are the result of effectively maintained barriers to competition -- think Microsoft, think Intel. What is going to be Google's counterpart permanent edge?" DeLong's question is clearly rhetorical. He doesn't think it has one.

At least it is profitable, with a net profit of $US106 million on revenue of $US962 million in 2003, and a profit of $US64 million in the first quarter of this year. But since when have these sort of fundamental calculations had much to do with a dotcom IPO in the US?

If this was a normal IPO, by now the big US investment banks would be gathering their clients and friends, like WorldCom's Bernie Ebbers, for a killing. Google's shares would be hyped and then offered substantially underpriced, their price would rise sharply over the day, the investment bank's clients would make millions and in return there would be corrupt kickbacks, commissions, price-rigging and cigars all round.

Down the track a bit, those who bought shares from the bank's clients would be likely to find they were a bad investment. The chart shows how shares recommended as buys by investment bank analysts performed when their bank was involved in an IPO and when it wasn't. Suggestive, to say the least and it has a lot to do with the scandals on Wall Street.

But the co-founders of Google, Larry Page and Sergey Brin, aren't having anything to do with traditional Wall Street ways. They are conducting their IPO via an internet Dutch (uniform price) auction. They will use the auction to determine the final initial public offering price at which all shares will be allocated. Bids regarded as speculative or manipulative won't be accepted.

There are other provisions, but the important point is that if this auction works, the beneficiaries will be the issuing company and its existing shareholders, not the investment bankers' pals. Ordinary shareholders, who can bid for as few as five shares, may also benefit from a price that does not collapse after the IPO -- although we will have to wait and see.

It would be premature to declare an end to Wall Street's old ways, but it will at least be interesting to see how the auction works. If it succeeds, I can think of at least one relevant issue for Australia.

If the Howard Government wins and goes ahead with the sale of the remaining 50 per cent of Telstra, why not do it by auction and cut out a lot of the fat commissions to brokers and investment bankers? After all, with half the company already in the market it should hardly be difficult for bidders to arrive at a reasonable price for the remaining shares.

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