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Google Offers Post-IPO Scenario

If Existing Shares Are Sold, Price Could Drop

By David A. Vise
Washington Post Staff Writer
Friday, August 6, 2004; Page E01

Investors who buy into Google Inc.'s initial public offering of 24 million shares could soon find themselves in a much bigger buyer's market than they expected.

That's because within six months of the IPO, early-stage investors and employees may choose to sell as many as 262.5 million additional shares they already own, the company disclosed in a filing this week with the Securities and Exchange Commission.

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If 10 times as many shares are dumped on the market as are issued in the IPO, the potential downward pressure on the stock price could be significant.

Google has estimated the range of its IPO as between $108 and $135 per share, which would make it one of the highest-priced initial offerings ever. In that range, shares of the immensely profitable firm would be sold for more than 150 times the company's annual profit per share, compared with the historical average of about 20 times profit for the nation's biggest corporations.

The additional 262.5 million shares that could be sold within six months are subject to varying restrictions regarding when they could come onto the market. The pressure on the stock price could begin as early as 15 days after the IPO, when 4.6 million more shares will be eligible for sale; could grow after 90 days, when 38.5 million more shares could flood the market; and could mount further after six months, when some 170.8 million additional shares would be eligible for sale, Google disclosed.

"Sales of our Class A common stock in the public market after the restrictions lapse . . . or the perception that those sales may occur, could cause the prevailing market price to decrease or be lower than it might be in the absence of those sales or perceptions," the company said in its SEC filing. "As these shares become available for sale and are sold into the public market, the market price of our Class A common stock could decline."

The potential overhang of more than 200 million shares of stock is one of a number of financial and legal risks that investors in the company's unconventional IPO face, even as the days for bidding on Google stock in the online auction being conducted for its shares dwindles.

In its latest filing with the SEC late Wednesday, Google disclosed that it may have violated numerous laws by illegally issuing 23.2 million shares of its stock, and nearly 6 million stock options, to hundreds of consultants and company employees without first registering the shares properly with state and federal authorities. The company said it may have violated the laws of more than a dozen states in the process of distributing those shares.

In a bid to address the problem, Google immediately offered $25.9 million to the owners of those shares to entice them to sell their holdings back to the company. However, a senior company executive and a major shareholder have indicated they do not intend to sell their shares back to Google under the proposal, and the company said consultants and other employees also could reject its offer as too cheap and file lawsuits against the company instead, according to SEC filings.

Google also said the surprise problem with the unregistered shares could delay the timing of its proposed $2.7 billion IPO, on which the cash-rich company had hoped to move forward as early as next week. In its latest disclosure, Google said the IPO will take place "as soon as practicable" after its lengthy offering statement receives approval from the SEC.

Google disclosed that one of its executives, who holds 52,783 shares of common stock that fall into the questionable category, and one of its major early-stage investors, who owns more than 1 million such shares, do not intend to sell their holdings back to the company under the terms of the proposed repurchase plan. This could discourage others from selling shares back to the company and set the stage for a legal fight.

The embarrassing muddle over the shares is an indication of the new type of challenge Google will encounter as it makes the difficult transition from a rapidly growing private company to a public company operating in the spotlight. This is particularly true in Google's case, since its IPO would be one of the biggest ever, and because millions of computer users around the world use its search engine to find information quickly on the Internet. Google said it has more than enough cash to handle the proposed repurchase of stock and options. As of June 30, Google reported $548.7 million in cash.

In the first half of 2004, Google reported nearly $1.4 billion in revenue, mostly from ad sales, and $143 million in profit. That represented a big jump over the first half of 2003, when it recorded $559.8 million in sales and less than $58 million in profit.

Since it derives nearly all of its revenue from ads, the company has been searching for new ways to sell them. Google has partnered with other Web sites, large and small, which now feature a Google search box and ads sold by the firm. In addition, the company recently launched its controversial Gmail product, which places ads beside e-mails.

Google has warned of two other major risks for investors. First, it has said the auction method being used to sell its stock may lead to a high price in the IPO, which could lead its shares to fall in price immediately after the offering. Google also has disclosed that it faces intense competition in online search from Yahoo Inc. and growing competition from Microsoft Corp., which recently revamped its search engine and is investing heavily in developing new ways to search the Internet and the hard drives of personal computers.

Google has transformed the way people hunt for information online, giving them an efficient way to find answers to their queries free of charge. The firm was started in 1998 by two doctoral students at Stanford University. They remain its biggest shareholders and will control the company after the IPO through stock that has greater voting power than the shares being offered to public investors.

Google officials declined comment, citing SEC restrictions on what they can say during the "quiet period" preceding an IPO.

© 2004 The Washington Post Company