TOPICS > Economy

Going Public

April 30, 2004 at 12:00 AM EDT


JIM LEHRER: Finally tonight, Google goes to Wall Street. Spencer Michels begins.

SPENCER MICHELS: Google, the unconventional private Silicon Valley company that has made a lot of money with its search engine, remained unconventional as it decided to go public. In announcing an initial public offering, or IPO, yesterday, it said it would sell its stock, $27 billion worth, through an innovative Internet auction system, a move that could revolutionize how IPOs are sold. And that created ripples throughout the investment community. The stock sale could give the company a value of more than $20 billion.

The company, which developed the highly popular Internet search engine six years ago and has refined it ever since, had never before publicly disclosed its finances. The filing with the Securities and Exchange Commission indicates the company made a profit of $106 million last year, up from $100 million in 2002. Its revenues were nearly $1 billion.

As part of their filing, Google’s two young co-founders wrote a letter to prospective investors emphasizing the company’s unique approach to business. “Google is not a conventional company. We do not intend to become one. … It is important to us to have a fair process for our IPO that is inclusive of both small and large investors. … This has led us to pursue an auction-based IPO for our entire offering.”

Even though large investment banks Morgan Stanley and Credit Suisse First Boston were chosen as lead underwriters for the IPO, shares of the company will be sold in an untraditional way. This is how an IPO normally works: The company hires investment banks, which handle the deal. After promoting the stock with big investors like mutual funds, the bankers set a price — often below what the public is willing to pay. Then, they sell most of the stock to those investors and to companies and a few favored individuals they do business with. The company gets the proceeds, minus a 7 percent commission for the bank. Finally, when the stock begins to trade publicly and the price goes up, as it usually does, many of those large investors sell their shares for a quick profit and then reward the investment bank through increased business for cutting them in on the deal.

Jason Lindsey, who was chief financial officer of the Internet company Overstock, says that system shortchanges the company issuing the stock by pricing it too low, and favors the investment bank and large investors.

JASON LINDSEY: Well, the normal IPO process is good for the bankers and their rich clients. The big banks are like a bunch of bullies and they can price it at whatever they want to price it at.

SPENCER MICHELS: Lindsey helped overstock go public in 2001 using an alternative method known as a Dutch Auction, or an open IPO, A method similar to what Google will use to sell a portion of its stock. The auction opens the process to small investors who were excluded before. Now, they, like the large funds, can buy the stock at its initial price.

Here’s how an auction works: After promoting the stock with large investors, the investment bank puts the stock up for bid to anyone who is interested. The price is determined by the demand; the highest bidders get the shares. Consequently, the stock doesn’t usually soar when it hits the stock market. According to Google’s documents, the company does not want investors to immediately sell, or flip, its stock for a quick profit. The company says its investment banks will only accept bids from investors who are customers and who meet certain “eligibility and suitability” requirements. The auction was developed by investment banker Bill Hambrecht, who talked about it on Frontline in 2002.

WILLIAM HAMBRECHT: The only way you can ever take the possible excesses out of the system is to have a non- preferential way of allocating the stock. It’s got to be fair. It’s got to be open. And in that way, you get rid of the kind of things that sneak into a system where you have preferential allocation. That’s why we came up with the auction.

SPENCER MICHELS: To insure they retain significant control of the company, Google’s founders, Sergey Brin and Larry Page, created two classes of stock: One already held by company insiders, and another for outside shareholders. The insider shares will have ten times the voting power, keeping control of the company with the insiders. Brin and Page wrote: Google’s nontraditional approach to the IPO process will be closely watched by the investment community, which has defended the traditional IPO and disdained the auction. Google shares are expected to hit the open market in a couple of months.

JIM LEHRER: Ray Suarez takes it from there.

RAY SUAREZ: What does the Google IPO tell us about the company and its strategy going forward?

For that I’m joined by Charlene Li, principal analyst covering technology, media and marketing at Forrester Research. And, Charlene Li, you’ve got Sergei Brin and Larry Page, they’re young, they have a great technology, a fast-growing company. They look set to make a lot of money. Why go public at all?

CHARLENE LI: Well, a couple of things. First of all, they have some very entrenched and very powerful venture capitalist funders in their company who invested back in ’98, and the way that they make money is by having a liquidity event, and so having the shares go public is a great way for them to get that money out. They need to do that because they want to make more money, to make more investments and having a great jewel like Google go IPO on them would make a great addition to their portfolio.

On top of that, Google is at the very top of its game right now. It’s really fostered and flourished over the past couple of years because there’s been very little competition. But right now we have people like Yahoo!, Microsoft, AOL — a lot of other people gunning for Google’s top position. So again, it’s a great time for them to go. They have a lot of confidence, very loyal users, and they need the cash in the future to compete against the competitors.

RAY SUAREZ: Well, I was going to ask you that. It sounds like from your earlier explanation that this is more a question of turning value that’s already been created into cash than it is raising money to develop the next big thing that Google is going to do.

CHARLENE LI: Well, again, they have almost $1 billion in revenue, so they definitely have proven their business model, they have almost half a billion dollars in cash, so they have quite a bit of money already in place, so they could always use more money to make acquisitions, to compete against someone with very deep pockets like Microsoft. But in addition they have shareholders already. They are venture capitalists, employees, for example, who need motivation and again be able to take some liquidity in the marketplace because those options are not worth very much unless there’s a marketplace where they can trade them.

RAY SUAREZ: Are they structuring this initial public offering in an unusual way, in a way that creates new shareholders but still leaves the company in control of its founders?

CHARLENE LI: Well, again, they have been running the company in a very different way from the beginning. They have had a very sound philosophy that they will do business in a different way. This is unusual. They see the excesses of the dot-com era where a lot of businesses came up without a strong business model and they built a strong business here but essentially they are trying to maintain control over the company.

That’s why they have two shares — two classes of stock, and so by maintaining that control, they want to be able to allow that liquidity to happen but they don’t want to give up control of the company. And especially in a market that’s very driven by quarterly earnings. They are sending out a message. Look, if you’re going to buy Google stock, beware that this is not again going to be your typical shareholder situation. You’re going to have to get used to us doing business in a very different way.

RAY SUAREZ: Does that different way include still being able to run the company as if there aren’t a new couple of million pairs of prying eyes looking over your shoulder?

CHARLENE LI: I think ideally they would love to think that’s the case, and to the extent that they would try to keep those people at bay and not influence a decision, so going to want to do that. Again, they — they are basically saying to the shareholders, “You’re investing in a company and an executive team that really knows what’s going on, and either you buy into us and our strategy or you don’t. And sure, we’ll be listening. We’ll be listening to our advisors and listening to what the market says but we won’t be beholden to quarterly earnings, quarterly expectations because frankly we need the flexibility and the speed in the marketplace to be sure to do the right thing.”

RAY SUAREZ: Isn’t Google up against some pretty big players in the online world as it tries to broaden its mandate beyond just strictly search?

CHARLENE LI: They are. Again, they have been in the search space with the technology they have had for quite a few years. But it’s only been in the past two years that they have gotten into their new revenue streams, which is advertising dollars. Now they are getting into the space of, for example, Yahoo!

Of online advertising, another giant, MSN from Microsoft, AOL, and these sites again are traditionally known as portals, where people will go and have Web sites, address books and see a lot of contempt. Google has said they don’t want to become a portal, and they are staying far away from that, but the reality is they are making the money in very much the same way and they are stealing consumers and advertisers from these competitors, too, as well, so these companies are going to be chasing after Google in a very big way. And they are going to be — they are already starting doing that.

RAY SUAREZ: You say they don’t want to be a portal. Even with their — what is generally conceded to be excellent technology, the ease of doing an online search, can they remain just a search engine and be successful?

CHARLENE LI: Well, they say they don’t want to be a portal in a traditional sense, for example, a Yahoo! homepage or MSN homepage, which has tons of content all over the place. But in many ways, they are already functioning as a portal. The traditional role of a portal is the starting place for your Internet experience. They have a very good search engine. They have a shopping site called Froogle. They have news on Google news, and they recently announced e-mail, so even though they don’t have it in sort of a traditional way, they are functioning in many ways in the same way that someone like a Yahoo! or MSN or AOL are doing.

RAY SUAREZ: Going public means you have to start telling the public about your company, about how money moves from here to there, who owns what. The filings they had to make to go public, did they tell you anything previously unknown things about the Google world?

CHARLENE LI: Yeah. One thing in particular is they have some distribution partnerships that are very interesting. They are actually losing money on some of these agreements, and as a public company you kind of say, “Well, why are you having this loss?” But as a private company they obviously decided that these were relationships that are worth having, so if you look at them on an individual basis, that may be surprising. But taken as a whole, somebody if they have a relationship with a very large site like AOL or Ask Jeeves, it may be worth it because they can use that distribution, that leverage, that traffic, in order to sell more advertisements across the entire network. That way they would actually get a better margin someplace else because they have a bigger network, because of these deals.

RAY SUAREZ: Charlene Li, thanks for joining us.

CHARLENE LI: Thank you.