Should You Invest in Google?

By Daniel Kadlec Sunday, May 02, 2004
    • The worst-kept secret in Silicon Valley is finally out: Google, the Internet search engine with legions of digital devotees, will sell shares to the public sometime this summer. The crush of interest that has surrounded what will be a highly unusual initial public offering (IPO) of stock is in many ways justified. Google is that rare Internet success story — profitable since 2001, with revenue that soared nearly threefold since then, to $962 million, last year.

    Yet in their attempt to create a corporate utopia, founders Sergey Brin and Larry Page are creating two stock classes — one for themselves and one for the rest of us, who must bid through what's known as a Dutch auction. For a variety of reasons, it's not a stock you need to rush to own.


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    Google's IPO filing with the Securities and Exchange Commission last week removed the cloak from the secretive company's financial health, and the numbers dazzled. "We were amazed," says Kathy Smith, an analyst at Renaissance Capital, an IPO-research firm based in Greenwich, Conn. "We never expected to see such a large, profitable company." Google is used by more than 100 million people a month and sells text-based ads that Web surfers actually want. Revenues are just a third less than Yahoo's. The company expects to raise $2.7 billion from the IPO, which would make it one of the largest tech deals ever.

    But the way the IPO is being handled virtually ensures that there will be no quick reward. The stock is as likely to fall as to fly on the first day of trading. The filing reveals a reluctance to go public, even though the two founders, former Stanford computer-science graduate students who together will own about 32% of the company's shares, could emerge worth some $4 billion each. In a folksy manifesto that's part of the filing, the founders liken themselves, a tad arrogantly, to Warren Buffett, saying they will take risks as though Google were a private company and will offer no guidance on predicted earnings.

    There are worse role models than Buffett. But many find it disconcerting that the two classes of stock will allow the pair to sell most of the company if they choose to, yet retain voting control. The stock that Page and Brin keep will have 10 votes for every one that common shareholders get. Dual-class stock is rare, though it exists at companies like Dow Jones, Viacom and Buffett's Berkshire Hathaway. Although some of these stocks perform well, activists dislike the structure.

    Perhaps the biggest red flag is the auction that Google will use to distribute shares. The process allows all investors to enter a bid. That's fairer than most IPOs, in which only the well-connected get a chance. But unlike a typical auction, in which the highest bid sets the price for all shares, Google's reserves the right to add more shares, which would lead to a lower per-share price. Why do such a thing? To make sure the IPO price doesn't hit an unsustainable level — a risk at any fevered auction.

    It sounds good coming from a pair who say in their filing they "aspire to make Google an institution that makes the world a better place." And maybe they really are looking out for ordinary investors. If you're smitten, submit a bid in the range that Google will supply in coming weeks. Multiply the price you bid by the number of shares outstanding (when that becomes available) to make sure you're valuing the company at less than the $30 billion that analysts believe is the most that Google is worth.

    But, says Steven Tuen, a co-manager of the Kinetics Internet Fund, "I see no urgency to bid." The typical IPO sold at auction rises less than 7% the first day. So there isn't a lot of risk in simply waiting for trading to begin. By then you'll know who sold what, and you just might get a better price.