172 Pages… and Questions Remain

Plowing through Google’s huge registration statement with the SEC is a bit like reading entrails. Exactly what’s going to happen is left to the reader’s imagination.

In its Form S-1 filing on Thursday, the first step in a company’s going public, the Mountain View, Calif.-based search company left a lot of blanks. The famously secretive Google did not disclose when it would go public, what its ticker symbol would be or which on exchange it would trade.

The public and competitors got a look at the company’s finances, which were as good or better as the speculation, with nearly $1 billion in revenue last year. Now, how to get a piece of that? The most interesting unanswered question is exactly how the IPO shares will be sold.

Google named two investment banks, Credit Suisse First Boston and Morgan Stanley, both Wall Street institutions. At the same time, it said that all shares would be sold using the auction method. But the devil is in the details, and there are no details about how Google and its old-school investment banks will carry out the auction. There are some hints that Google may take a do-it-yourself approach, providing the technology and letting the bankers handle the money.

In the traditional IPO process, known as book-building, the investment banks set the initial offering price, frequently set the initial price below what they think the stock could fetch, so that those who buy IPO shares are sure to profit. Most of the shares are offered to institutions and the bank’s favored customers.

In an auction, would-be investors bid for a set number of shares at a set price. When the bidding is over, the bank finds the “clearing price,” the highest price at which it can sell all the shares. That becomes the maximum offering price for all shares. Anyone who bid below the final offering price doesn’t get shares; those who bid at or above the final price will get shares. All bids are treated equally; the share allocation is based on price and has nothing to do with the size of the order or the bidder’s relationship with the underwriter.

Investment firm WR Hambrecht, which champions the auction process for IPOs and provides technology and management services, isn’t listed in the SEC document. One intriguing possibility is that Google will use a version of its own bid-for-placement advertising technology to handle the bids.

“Our experience with auction-based advertising systems has been surprisingly helpful in the auction design process for the IPO,” the founders’ letter said. Its AdWords cost-per-click online ad-buying service provides a level playing field for advertisers with its open bidding system. Whoever offers the most for a specific keyword gets the top ad.

While Page and Brin in their founders’ letter said they chose an auction so that all qualified investors would get a chance to bid, there’s a question as to just how “open” the auction will be. According to the SEC filing, bidders must be customers of one of the banks handling the IPO. Executives didnt return calls, but during an earlier period of Google IPO mania, Clay Corbus, Hambrecht senior managing director of investment banking, told internetnews.com that the process is not completely computerized nor automated. All bids still are entered through a brokerage account and approved by a broker.

CSB handles investing only for institutions and the super-rich, while Morgan Stanley manages accounts for individuals. Its Internet trading accounts require a $50,000 minimum; smaller investors can open accounts, but trades must be handled by a broker.

The company aims to let bidders buy at least 80 percent of the shares they ask for. But unless Morgan Stanley or Google provides access to some specialized secure web site for all brokerage customers, those brokers could be a bottleneck. (Hambrecht provides access to its OpenIPOs through fax and phone, as well as the Internet.)

Google has the option of adding more banks to its team, and Bryan Armstrong, a partner in the investment advisory firm Ashton Partners, speculated that the company might include an Internet-based trading company like E*Trade to the roster.

“I’d think they’d open it to at least a couple more retail-friendly banks,” he said.

But there are plenty if things that could go wrong with this untested process — and there’s no way to do a beta release of the IPO. According to Keynote Systems, a Web performance measurement and management provider, the SEC Website saw a 900 percent increase in traffic the afternoon Google filed, and its performance dropped to 29 percent of normal. Google is thought to be building one of the world’s largest super computers, but still, if it hosts the auction, it risks a meltdown.

“I think there will be disappointed investors,” said Tom Taulli, a fund manager and author of the book Investing in IPOs, “after their putting out this letter saying, ‘We’re democratic, everyone gets a shot at it.'”

Could the Google cachet — combined with investor backlash against Wall Street — fuel a trend toward auction IPOs?

“I think it should,” Armstrong of Ashton Partners said. But not everyone is in Google’s fortunate position, he added. “Companies of a significant size, say $1 billion threshold, that have a decent amount of visibility, and either a strong brand, well known management team or easy-to-understand business story can get away with doing a Dutch auction,” he said. Others would do well to avail themselves of the
sales job performed by underwriters.

The stakes are high: More valuable than $2.7 billion is Google’s good will. The peace-and-love sentiments espoused by the founders could be dashed against the cold, hard Street.

Whether they screw up or not, “The auction is a huge event in the world of finance, Taulli said. “And it will be something new for institutional investors, as well.”

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