Sucheta Dalal :Google's unorthodox IPO Googly
Sucheta Dalal

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Google's unorthodox IPO Googly  

May 3, 2004

If the new experiment clicks, it could change the rules of the game for everybody else too.

Google's unorthodox IPO Googly

By Sucheta Dalal

It is seen as a “salve for battered Silicon valley”; the hope of the venture capital industry; and just the event to improve George W Bush’s electoral chances. Wall Street has turned hysterical over Google’s proposed $2.7 billion initial public offer (IPO), announced as a part of the mandatory filing that it made to the Securities Exchange Commission (SEC) last week. Investors jammed SEC’s EDGAR site, in trying to get hold of Google’s filing and Internet message boards discussed little else last Thursday.

Yet, as The New York Times says, “Wall Street loves Google, but the feeling isn’t mutual” or as Fortune puts it, “nearly everything is unorthodox” about Google’s filing. And that is what interests us.

Google, which is the worldwideweb’s (www) most popular search engine, has enthused the IT world by posting a net profit of $100 million earned almost entirely from advertising. Its business expansion plans such as the Gmail (being tested) have rattled competitors by offering a whopping one gigabyte of free storage space. This is 100 times more space than its competition. Is it any wonder then that Google is expected to list with a phenomenal market capitalisation of $25 billion or more, turning its three young promoters into instant billionaires.

Such fairy tales occurred routinely during the Internet bubble and ended in tears for investors.

But Google is different; as Fortune says it is ‘unorthodox’. Here is what it has proposed. Google plans to defy Wall Street’s powerful investment bankers by taking the public auction route to sell its shares. Its online auction is designed to give both large and small investors a fair chance of getting an allotment. This is contrary to the US practice, where the lead management team allocates the bulk of an IPO to favoured individuals or friendly institutional investors. Google instead warns investors not to invest in the hope of making short-term profits by flipping their shares on allotment.

Second, Google will cock a snook at new corporate governance trends in its top management structure. At a time when mammoth pension funds such as California Public Employees Retirement System (CalPERS) are demanding separation of the posts of chairman and CEO, Google will be run by a triumvirate of equal partners. Investors can take it or leave it. The Google trio says that the structure has worked for them so far and don’t see any reason to change it.

Third, while investor groups are lobbying for companies to have a single class of shares, with no special voting rights for any group, Google has opted to call itself a media company and will have two classes of shares. The management will hold Class B stocks that will enjoy the same economic benefits as the publicly traded Class A shares, but ten times the voting power. Effectively, public shareholders will not be co-owners only economic beneficiaries. Every single decision will be dictated by the management, which has 10 times the vote for every publicly held share. In fact, the company’s SEC filing argues that “companies cannot manage for the long term unless investors and analysts have limited say in the way they are run”.

That effectively turns corporate governance rules on their head. Over the last few years, every good governance codes, especially the Indian ones have focussed on investors and independent directors dictating how companies are run. CalPERS and other institutional investors successfully used their collective clout to force Walt Disney to oust Michael Eisner from the post of chairman and they plan to enlarge the campaign. Google is effectively telling investors that it won’t let them meddle with management. To which, some market experts say, “if you don’t want to listen to others (read investors), then don’t go public”. But the frenzy over Google’s IPO suggests that this is a minority view.

Google’s unconventional IPO filing also says that it will inform investors differently. It wants to avoid pressure from investors for better and better short term earnings growth, that had caused so many American companies to fudge performance numbers just to keep their stock prices high.

Larry Page, one of Google’s founders writes in the ‘Letter from the Founders’ that: “A management team distracted by a series of short-term targets is as pointless as a dieter stepping on a scale every half-hour”. So, it does not even plan to offer quarterly earnings guidance and expects shareholders to understand short-term losses if and when they occur.

Of course, Google can dictate terms now because it is hugely profitable. It had an operating margin of a fat 62 per cent in 2003 and its powerful competitors have yet to pose a serious threat. If Google rewards investors well, trades well above its initial offering and continues to grow at the same pace, it could well change conventional rules on how publicly listed companies must be managed and guided by disclosure rules.

Google’s success could embolden successful companies around the world to experiment with different forms of IPOs and limit the pressure from investment bankers and institutional investors. For instance, there is no reason why Indian companies, who dislike the needless hype surrounding successful IPOs cannot close book built issues as soon as they are fully subscribed. After all, IPOs are meant to raise a fixed amount of money and should be closed once they are fully subscribed.

Or, profitable public and private companies under pressure from bankers to make cumbersome, simultaneous offerings of shares in India and abroad, could say an emphatic no. After all, investors are not interested in such offerings and investment banks are the only beneficiaries.

Companies such as Infosys, who have suffered the consequences of making conservative earnings forecasts in the past, may also want to tell investors to start showing more trust in management and not provide earnings guidance.

In fact, the very structure of mandatory corporate governance codes which prescribe the number of independent directors, structure and responsibility of audit and remuneration committees etc may begin to be questioned. This will happen if unorthodox management models like that of Google work well, while those that follow mandatory codes end up with cosmetic compliance rather than genuinely good corporate practices.

Google’s bold new experiment is sure to be watched carefully by academics, regulators, market intermediaries and investors, because it could change the rules of the game for everybody else too.

Writer’s e-mail: [email protected]

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-- Sucheta Dalal