Initial Public Offering by Google - Essay Example

Google's Initial Public Offering The performance of Google, which debuted using the online auction process in August, 2004, does not suggest that the online auction process served as an efficient pricing mechanism since it did not minimize Google's first day price surge. "When Google filed in April 2004 to go public, it outlined an unusual IPO method that was widely seen as an assault on Wall Street practices. In place of the standard system -- in which underwriters sometimes had let favored investors buy shares and priced the offerings low so those investors made quick gains -- Google would use a "Dutch auction."" (Delaney, September 2005) Google's offer price was $85, and it opened at $100--reflecting an 18 percent increase. This increase between the offer price and the open price is much greater than the increase for typical IPOs in 2004. Indeed, 82 percent of the IPOs issued in 2004 experienced less of a jump from the offer price to the open price than Google did, and the statistics were similar for IPOs issued prior to Google's debut and following Google's debut. The enormous post-auction price increase of Google, especially in the immediate weeks and months following its debut, when there were few substantive news releases on changes in company strategy and fundamentals, further suggests that the online auction method may not have priced Google efficiently. Google subsequently soared in the following months to a high of $317.80 on July 21, 2005. As of June 29, 2005, Google had exhibited price appreciation of 186.8 percent, relative to its open price. Critics of Google's IPO initially argued that the auction was a failure because Google slashed the number of shares that it would sell at public auction from 25.7 million to 19.6 million shares. Also, it dropped the target price range from the $108-to-$135 range projected in late July to the $85-to-$95 price range (Knight Ridder, August 19, 2004). At the time, many analysts suggested that the earlier Google price range had been overpriced; yet, Google's closing price reached the lower end of that price range after 18 days of trading and reached the higher end of that price range after 32 days of trading. The lessening interest in Google at the time that it reduced the price range during the summer was possibly due to some combination of the following factors: - The lack of information provided by the company during the process about its uses of capital - A slump in price appreciation for June IPOs - Reservations on the part of investors about the use of the online process. Who benefited from Google's price appreciation Under the traditional process, the preferred clients of the underwriting investment banks can benefit from the initial IPO underpricing and subsequent price appreciation since they have the initial allocations. In the case of Google, the beneficiaries in the price appreciation have been: 1. those investors who bought Google when it first began trading and held it until the price increased substantially and 2. the Google co-founders and the chief executive, as well as the venture capital firm involved in financing Google, who were allocated shares early in the process, but who could not sell them until the "lock-up period" expired. "Google announced in its IPO prospectus that it wouldn't provide traditional earnings guidance. While it took this stance to avoid short-term thinking, the move also likely left Google's directors knowing more about company prospects than other investors. The third quarter, which Google was in at the time, proved to be one of spectacular growth." (Delaney, September 2005) By July 2005, the CEO Eric Schmidt and the company founders Sergey Brin and Larry Page had sold $1.7 billion in stock, other executives had sold more than $800 million in stock, and no open market purchases had been recorded. Indeed, Page and Brin have sold 3.7 million and 3.8 million shares, respectively, or roughly 400,000 shares per month, while Schmidt had sold 1.3 million shares, or 113,000 shares per month, beginning in November, 2004 (Wall Street Journal, July 27, 2005). The advantages of the online auction process must be weighed against its disadvantages. On the one hand, it increases the ability of small investors to participate in the IPO process and minimizes the traditional dominance of larger institutional investors, who are lucrative clients of underwriting investment banks. On the other hand, small investors may lack the ability to efficiently price an IPO due to informational asymmetries. "Wall Street bankers compare auction IPOs with selling fine art on eBay instead of at Sotheby's. The big Wall Street firms have good reason to defend the traditional model. Known as "book building," it entails gauging the interest of hedge funds and mutual funds in an offering. With fees of 7% of capital raised for most deals, it is lucrative. Book building also enables the Wall Street firms to dole out IPO stock at bargain prices to their best customers, which can be a boon if the IPO soars on its first day of trading." (Smith, July 2005) This information gap could arise because small investors lack access to the sources that institutional investors have or because companies are not required to provide detailed information in the online process, since they don't undergo the rigorous scrutiny of investment banks in the traditional bookbuilding process. As a result, the online process could be used more by companies that may not have a clear sense of the uses for the funds that they are raising or by well-known companies that may not have been successful in the traditional issuance pro-cess. However, investors could have difficulty in distinguishing successful companies from "lemons" and, consequently could end up discounting the price of all online IPOs due to this potential adverse selection problem. Use of the online auction process certainly provided publicity for Google's IPO, which may have stimulated the interest of small investors and others who are normally less involved in the process. It is unlikely, however, that the use of the online auction would generate such extensive publicity for a less well-known IPO. Indeed, the public may be exceptionally wary of a less well-known company that uses the online auction method to issue its IPO because of the lack of detailed information provided by the issuer in this process, relative to the traditional process. One of the principal advantages of the online auction process is supposed to be that the increase between the offer price and the open price of an IPO is minimized, which provides the issuer with greater value. Nevertheless, the online auction method for Google did not minimize its first day price surge, since 82 percent of the IPOs issued in 2004 using the traditional IPO process experienced less of a price surge. A broader comparison of the pricing behavior of auction IPOs with traditional IPOs by primary lead underwriter indicates that although the average offer-to-open price surges for the OpenIPO.com online auction IPOs exceed the average offer-to-open price surges for IPOs issued by 82.4 percent of the primary lead underwriters, the auction process was, on average, more efficient in pricing IPOs than the traditional process for medium-to high volume issuers, and less efficient than the traditional process for low volume issuers. A comparison of auction IPOs with traditional IPOs issued in the same year and in the same three-digit SIC code suggests that 44 percent of the auction IPOs have greater offer-to-open price surges than their traditional counterparts, and that 89 percent of the online IPOs exhibited more substantial subsequent price appreciation than their traditional counterparts. This suggests that the online auction mechanism is not as efficient in pricing IPOs as some have thought. On the other hand, the traditional process leaves much to be desired. With the recent Spitzer probes into a variety of common business practices--ranging from "bid rigging" in the insurance industry to market timing and late trading in the mutual fund industry--the general confidence of the public in traditional processes in the financial markets may be at a low ebb, making this an excellent time to develop new methods of IPO issuance. However, the newer methods will also have liabilities. With interest in IPOs rebounding and the growing belief of small investors that they can become involved early with new issues, it is likely that some of the weaknesses of the online auction may be improved. Issuing companies can partially alleviate the weaknesses by providing investors with sufficiently detailed information that good companies can be distinguished from lemons, so that the adverse selection problems can be minimized. The SEC reforms on the "quiet period" are the first step in eliminating informational asymmetry. Further requirements in the online process for detailed information from the issuer and greater involvement of all parties in the process are likely to lead to a more egalitarian and transparent process for providing new companies with capital. Works Cited Kevin J. Delaney. "Feeling Lucky: Google IPO Revisited: Insiders Got Choice Other Sellers Didn't; When Offering Price Was Cut, Some Sold Fewer Shares; Others Had to Sell More; Filling Out the 'Green Shoe'". Wall Street Journal. (Eastern edition). New York, N.Y.: Sep 16, 2005. pg. A.1 Randall Smith. "Why IPOs Still Use the Old Way" Wall Street Journal. (Eastern edition). New York, N.Y.: Jul 6, 2005. pg. C.1 Investment Dealers Digest. 2004. "The Quiet Period' Getting Overhaul." October 18. Knight Ridder Tribune Business News. 2004. "Google IPO Fails to Find Results It Sought." August 19. -----. "Google Shares Climb $23.05 as Search Engine Revels in Profits." October 23. Los Angeles Times. 2005. "Google Plans Second Stock Offering." August 19. New York Times. 2005. "Google to Offer Instant Messaging and Voice Communications on Web." August 24. -----. "Google Gets Better. What's Up with That" August 25. San Jose Business Journal. 1999. "Bidding Begins on the First-Ever Internet-Based IPO Auction." February 12. Wall Street Journal. 2004. "Engine Trouble: How Miscalculations and Hubris Hobbled Celebrated Google IPO." August 19. -----. "IPO Quiet Period Could Be Getting A Lot Louder." October 27. -----. "Google's Backers, Executives Cash In." November 22. Wall Street Journal. 2005. "IPO Outlook: SEC Proposes Increasing Role of Web in IPOs." January 3. -----. "Morningstar Bets on Bidders for IPO." January 10. -----. "Auction IPOs: First Google, Now Morningstar." January 11. -----. "Why IPOs Still Use the Old Way." July 6. Read More