With their initial public offering (IPO) this month, Google's founders and biggest shareholders Larry Page and Sergey Brin -- the fellows who vow that theirs is "a company that does good things for the world even if we forgo some short-term gains" -- -are on the cusp of becoming googolaires. Or, at least, multi-billionaires. This isn't your average Internet IPO. For one thing, the company expects to have a share price that would value the company at as much as $36 billion. For another, it's selling shares through an auction -- cutting out the investment bankers who traditionally get shares on the cheap and allocate them to their buddies, who cash in when the stock prices soars on the opening day of trading.
The auction is a good way to launch an IPO, says Yale School of Management professor Barry Nalebuff. But, he adds in a piece in Sunday's Outlook section, that doesn't mean you should run out and take part in it. In fact, says Nalebuff, an expert in game theory, investors would be better off avoiding the auction, then waiting a day, a month, or even a couple of years before buying shares if they really want to own a piece of Google. His advice has nothing to do with Google in particular. It has to do with the nature of auctions and the so-called winner's curse. If you bid too low, you might not win. And if you do win, it's likely that you bid too high.
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Nalebuff will discuss his piece -- Going Once, Going Twice, Let It Go... -- on Monday, Aug. 9, at Noon ET.
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Fairfax, Va.:
I am getting sick of hearing about Google and its soon-to-be-billionaire 30-something CEOs. The company does not have any substantial proprietary technological edge in any of its services, either current or proposed. It will at best end up being another Amazon -- an internet firm with a decent but not outstanding revenue stream, minimal profits, with a stock valuation out of all proportion with reality, and kept going by institutional investors who bought into the hype and now cannot afford to let it fail. Meanwhile, these two guys seem to spend most of their time posing for magazine covers. Is this 1998 all over again? Hasn't anyone learned anything?
Barry Nalebuff: I think it is fair to say that Amazon has created a business with long-run value. They have been able to move beyond books and music to a wide variety of consumer products.
If Google is able to do the same (capture email for example), then they too might deserve a rich valuation. But, so far, they haven't done it.
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Washington, D.C.:
How do you think Google will do in the long-run?
Barry Nalebuff: I think Google will do great as a company. But that isn't the same as that they will do great as a stock.
Take Priceline. My hat goes off to Jay walker for creating a billion dollar company with the simple idea of letting customers state the price to the airlines. The only problem is that there was a time when the stock was valued at nearly $30 billion.
You can have a great company and have a stock valuation that is even greater.
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Silver Spring, Md.:
Who are google's main competitors and is there anyone with a chance of overtaking them in the search business?
Barry Nalebuff: First, you should have a look at the Prospectus, which lists a long list of competitive threats.
Other companies offer search, including Yahoo and Microsoft. Microsoft's search is not as good as Google's so far, but this is one of their priorities going forward.
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Anonymous:
Many big corporations have been hit real hard with scandals. Do you think that the IPO auction is a smart marketing strategy for Google to say that they care about their clients and employees more than corporate bigwigs?
Barry Nalebuff: Is it smart in that it has earned them priceless PR. But I note that they would have been even kinder to their investors if they had said: "We think the IPO price is 140 and we are going to sell shares at 120" and then give everyone the chance to get at least 10 or 50 shares.
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Arlington, Va.:
Isn't any stock purchase essentially an auction, usually conducted by an exchange? How is buying into Google's IPO qualitatively different?
Barry Nalebuff: You are correct. The difference is that with the exchange auction outcome, you can see the price before you bid. In the IPO auction, you can't. This creates a greater risk of something called "Winner's Curse." If you bid too low, you most likely won't get shares. But if you bid too high, you most likely will get shares. Thus getting shares is an indication that you bid too high.
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Arlington, Va.:
Totally unrelated: What do you do in the gaming field?
Barry Nalebuff: I have several books on game theory and business strategy. Thinking Strategically explains game theory without too much math. (You can figure out what John Nash really did.) Co-opetition explains the theory of competing and cooperating at the same time. Why Not? is my latest book. Have a look at http://www.whynot.net and http://mayet.som.yale.edu/coopetition for more info.
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Clifton, Va.:
So I'm trying to understand -- auction or no auction -- is Google a good investment?
Barry Nalebuff: I'm afraid that your question cannot be answered without regard to a price. Google may be a fine investment at $50/share and a bad investment at $150/share.
The question is what is the right price for Google and can you buy it at that price.
The problem is that google is very hard to value as almost all of the value comes form the future. Companies can be valued based on their present flow of earnings.
After taking account of dilution for options, Google is on track to make somewhere around $150 million this year. Thus if their earnings didn't grow, they company might be work $1.5 billion.
Since the IPO valuation is expected to be somewhere in the $30 billion range, that suggests that almost all of Google's valuation is based on "hopes and dreams" of future profits. These are notoriously difficult to value.
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Washington, D.C.:
How could Google possibly be the "next Microsoft or Dell," as you mention in the article. They don't really produce anything. There's no product. Is this IPO the biggest swindle in the history of the stock market?
Barry Nalebuff: I think information is a good. What Microsoft puts on its disks is information. Google produces an index of the web that is easy to search. Given the information overload, a good index makes the rest of the web valuable.
I recall that TV Guide, essentially an index of TV listings, was once worth as much as any of the the TV networks.
As a professor, you could also ask me what universities produce. My answer would also be knowledge.
The fact that their product is intellectual property doesn't make it ether. But it also shouldn't give them a free ride in terms of valuation.
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Maryland:
How would Google rate the success of the auction?
Barry Nalebuff: The first measure of success is a lack of something bad happening. Provided the IPO actually comes to fruition it will be a success. The second measure is how well they have done in creating a base of loyal shareholders.
Note that they are going to be selling more shares to the public very soon (4.5 million shares in 15 days and another 38.5 million in 90 days are eligible to be sold). Thus will the IPO set them up to succeed in these secondary offerings.
If I were in their shoes, what I would want in my ideal world is a wildly oversubscribed IPO where I could set the price at 130 while telling people that demand would have equaled supply at 150. Then investors could feel good and there could even be a small pop in price.
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Virginia:
Do you see many other companies that would follow after Google in share auctions. Or do you think that a lot of companies think that Google is crazy but would consider a similar strategy if Google comes out successful.
Barry Nalebuff: I do that the the IPO auction makes sense. I am in the paradoxical position of recommending that you don't bid in it while also hoping that this format takes off.
One could also employ something that is used for Treasury (bonds). The stock could start trading on an "when issued" basis. People could trade the stock today knowing that stock will be sold on the market in two weeks. You don't actually need anyone to own the stock to trade it.
The problems with this IPO are twofold: (i) this company is harder to value than most, (ii) the hyped up auction it is likely to bring in more novice bidders than most IPO auctions.
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Icebergvillle, Minn.:
Haven't we lost sight of the point of an IPO?
The idea is to raise capital for your company. Isn't it mismanagement to try and get anything less that what the market will allow?
The IPO craze on the 90's where insiders received huge gains on short-term holding, only hurt the underlying company's chance at capital.
Barry Nalebuff: About half of the money being rased in this IPO ($1.6 billion) will be going into the company coffers while the other half will be going to the founders, venture capitalists, along with Yahoo and AOL.
Even to the extent that the stock is sold for too little, one can't say that the investors buying the stock are getting hurt. The company may be worth less (in that it has less cash), but the buyers have paid less for their shares.
Thus the only people who might be hurt by an underpricing are the existing owners. (You could also argue that the company's future would be less bright if it didn't raise the cash it needed. But right now google says it has no pressing uses for the cash and intends to invest in treasuries.)
Okay, buy why not squeezeout every penny that you can from investors?
Remember that this is not your last call at the well. They are only selling 10% of the company. Thus if investors feel bad about the company, this could hurt Google even more when it comes to the secondary offerings.
It is useful to keep things in perspective. If you underprice the IPO by 10% but only sell 10% of the company, then you are losing only 1% -- not much in the grand scheme of things. It might be worth paying to generate investor goodwill.
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Alexandria, Va.:
Why would an average investor risk an auction IPO? Why not wait until the price settles a few weeks afterwards? Isn't that the best way to avoid "winner's curse"?
Barry Nalebuff: I agree entirely. Indeed, that was (I hope) the main point of my article.
Indeed, the surprising result from my finance colleagues is that one can even wait 3 years for the price to settle down without losing much of an opportunity to profit. (The average IPO underperforms the market over its first three years, taking as a starting point its traded price after 6 months.)
Trying to figure out what is going to happen on the first day is more akin to betting than investing.
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Washington, D.C.:
Where do you see the future of Google beyond being the mega search engine company? Do you think Google will keep the focus on being the ultimate search engine or start expanding to other forms of media?
Barry Nalebuff: I think we already know the answer to that question. Just as amazon has branched out beyond books, Google knows it has to branch out beyond searches.
Its proposed gMail service seems to be a winner by all early indications, even if its use of targeted ads based on message content is controversial.
I think it is best to view Google as a company based on ad revenue, similar to TV stations and newspapers. Its advantage to those businesses is that it has much lower production costs.
The question you have to ask is whether it can find $3 billion of profits a year from ads.
Other businesses Google could enter include auctions, job listings, dating services. It is already in the buying service game with Froogle. The Google news service is a potential competitor with CNN down the road.
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Fairfax, Va.
All I see are people talking about how the shares will be priced too high. Where are the people who are actually planning on bidding up to $150 a share for the IPO?
Barry Nalebuff: Presumably, they are not sitting in on this chat.
They are the folks who felt they missed out on Amazon and Microsoft. Perhaps they also feel that they don't have to worry about the price as even if they bid $150, they most likely won't have to pay this bid as the market clearing price will be much lower.
One thing to remember is that in the auction, you can't sell the stock short. So there won't be the same market control mechanism in the auction as will arise once trading starts.
Then there's the fact that many more shares are about to come to the market in the not-too distant future. This is a two-edged sword. The greater supply will push prices down. But Google doesn't want price to fall between now and then and so they have an incentive to underprice and ration demand.
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McLean, Va.:
How much do you think the founders' comments about doing social good as a company will hurt its IPO? As an individual, I might be inclined to reward that type of sentiment and invest in Google, but isn't that scaring off many large investors?
Barry Nalebuff: That's one of the things I like about Google. I prefer to invest in companies that are not run by jerks or egomaniacs.
So long as the company is clear about its strategy, investors can factor this in in valuing the stock.
Say the company decided to give away 10% of its profits to charity. That would just reduce the value by 10%, but it wouldn't (shouldn't) drive away large investors.
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