Souffle a la Google?

Google’s pricing of IPO shares is only a guide. If the clearing price goes higher, winners could end up feeling cheated.

The Mountain View, Calif.-based search company set a price range of $108 to $135 for shares in its initial
public offering, in advance of the Dutch auction to be held real soon now. The pricing follows SEC guidelines
for IPOs, requiring companies preparing to go public to give the market a realistic estimate of its worth.

The Dutch auction, which Google is using to set the final price and sell its shares, is designed, according
to proponents, to let the market decide the “real” value of the stock. In its latest SEC filing on Monday, the
company warned of the “winner’s curse,” the sinking feeling winners may experience that they’ve paid too much.

“The whole idea of the IPO auction is that people will bid what it’s worth to them,” said Ann Sherman, a finance
professor at the University of Notre Dame. In a Dutch auction, investors make blind bids for the stock. Then the
bankers figure the highest price at which all the shares could be sold. Those who bid that price or higher will get
shares; those who bid below this “clearing price” are out of luck.

The winner’s curse could set in if, when the smoke clears, those who won the right to purchase the stock found
that the trading price was less than the price they paid.

If the auction goes according to theory, Sherman said, investors who bid higher won’t feel ripped off, because
they won’t actually be paying that higher price. But because the market has gone gaga for Google, what she calls
“free riders” could push the stock way above a realistic price. Free riders bid higher in the auction than they
think the clearing price will be, just to make sure they get some shares.

“They’re trying to game the system,” Sherman said. “But the price may be unsustainable in the aftermarket.”

The system assumes that investors know what the stock is worth — at least to them. “But it takes a lot of good
hard work to get a reasonable estimate,” Sherman said. “If it’s hard to do your homework, you have people looking for
shortcuts.”

Melanie Hollands, president of the Koala Capital hedge fund, said the fact that the Dutch auction is blind is
as likely to run the price up as keep it down. “The Dutch auction is a big Internet black hole; no one can look into
it,” she said. “If you really want it, you’ll [bid] more.”

The result, Hollands said, will be a “souffli price. The auction can create an unsustainably high bid price, so
the stock crashes back down.”

Hollands said the chatter on the street is that a lot of funds are planning to buy GOOG, then quickly sell it off.
The high pricing range could be an indication that Google expects a sell-off, or it could be a way of creating cachet.

Tom Taulli, author of Investing in IPOs, said the non-professional investor should be wary, because the stock
will be volatile. Google’s buzz may be huge, he said, but the float is relatively small.

“For a company this size, 25 million
is a small amount of shares,” continued Taulli. “Yahoo , by comparison, has a 1.7 billion-share float.
It takes a lot more to move a share like Yahoo; for a stock like Google, with only 25 million shares, it doesn’t take
that much to move it.”

Taulli said serious retail investors should probably pass on the Dutch auction and pick up their shares later.

“There’s a learning curve here,” he said. “Investors have to read all this material and try to figure out how this
works.”

He added that, since one thing the Dutch auction is designed to do is keep the stock price from running up
in the first day of trading, Why go through this whole convoluted process? “Why not just wait a while and buy it with your
Fidelity account?”

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