Oct. 19 (Bloomberg) -- Google Inc.'s share price has risen 75 percent since the company's initial public offering in August, enriching founders, employees and investors. William Hambrecht, the banker who designed the search engine's auction IPO, sees too much of a good thing.

Hambrecht says Google underpriced its shares in the Aug. 18 offering, which at $85 raised $1.92 billion, a record for any Internet company. Google allowed big investors, with Morgan Stanley and Credit Suisse First Boston Inc., the banks leading the IPO, to dominate the bidding, he says.

``All the institutional business had to channel through CSFB and Morgan Stanley,'' says Hambrecht, 69, whose San Francisco- based WR Hambrecht & Co. was one of the eight co-managers. ``The institutions came in and said, `I want a 15 percent discount so I'll bid $85.' And they got it.''

Mountain View, California-based Google, which will report earnings Oct. 21, probably earned $111.8 million, or 56 cents a share in the third quarter, according to the average estimate of 14 analysts surveyed by Thomson Financial. A year ago, net income was $20.4 million, or 8 cents.

At its IPO, the operator of the world's most-used Web search service tapped its own technology and online audience to auction the shares through Internet bidding. It was the largest auction IPO ever.

Hambrecht says his own clients were willing to pay $97 a share, not $85. Based on that price, Google may have left as much as $270 million on the table. At $97, it would have received $2.19 billion for the 22.54 million shares sold.

`Underpriced the Deal'

Google's stock price, which soared 18 percent to $100.34 on Aug. 19, the first day of trading, is itself proof the shares were underpriced during the IPO, says Hambrecht. By yesterday, they had risen to $149.16, 75 percent above the IPO price, and traded as high as $150 in after-hours Nasdaq Stock Market trading.

Barry Randall, manager of U.S. Bancorp Asset Management's $100 million First American Technology Fund in Minneapolis, calls the stock's surge ``remarkable'' and agrees the issue was underpriced.

Randall bid $96 each for 10,000 shares of Google. His firm received 7,421 shares at the IPO price of $85, buying them through CSFB and Morgan Stanley.

``They underpriced the deal to create a traditional discount to ensure the stock price would move in the right direction,'' says Randall, 43.

CSFB spokeswoman Mary Claire Delaney and Morgan Stanley spokeswoman Melissa Stonberg declined to comment on Hambrecht's remarks or anything else related to the IPO, as did Google spokesman David Krane.

Founders Now Billionaires

In an auction, the company sets its share price based on the bids of all potential buyers, including individual investors, rather than through discussions between bankers and institutional investors as in a conventional IPO.

As a co-manager, WR Hambrecht advised Google in its discussions with CSFB and Morgan Stanley. It also took bids from its own investors, as the IPO's 27 other underwriters did.

Hambrecht says he helped persuade Google founders Sergey Brin, 31, and Larry Page, 31, and Chief Executive Officer Eric Schmidt to conduct their share offering as an Internet-based auction.

Brin, Page and Schmidt are now billionaires. The two founders each have stakes worth about $5.7 billion in the company they started six years ago in Page's Stanford University dorm room. Schmidt's holding is worth about $2.15 billion.

`A Traditional Discount'

Google's share price rose 8 percent more on the second day, to $108.31. That gave Google a market value of $29.7 billion, 25 percent more than General Motors Corp., the world's largest automobile company. Google's revenue comes from selling text advertising that appears next to search results.

At yesterday's price, Google has a market value of $40.88 billion, just ahead of Dallas-based Texas Instruments Inc., which makes chips for half the world's mobile telephones. In contrast to Google's 75 percent share rise, the Dow Jones Industrial Average has fallen 0.8 percent since Aug. 19, Standard & Poor's 500 Index has gained 2.1 percent and the Nasdaq composite Index, 42 percent of which is computer-related stocks, has gained 6.4 percent.

Auction IPOs are supposed to provide more stable, accurate pricing of a company's shares than do conventional offerings, says Hambrecht. The 10 auction IPOs his firm has managed since 1999 have raised $342.8 million. Shares in those offerings have gained an average 2.7 percent on the first day of trading, he says.

Conventional IPOs, by contrast, tend to leap more on the first trading day. The average opening-day increase in value of the 37 U.S. IPOs in the first quarter of this year was 15.5 percent, according to data compiled by Bloomberg. Shares of the 73 U.S. companies that went public last year rose 10 percent on average on the opening day.

Mixed Record

Not all Hambrecht-managed IPOs have posted low first-day increases. Shares of biotechnology company Genitope Corp., based in Redwood City, California, rose 11 percent after its $33.3 million offering Oct. 30, 2003. Hambrecht has also missed in the other direction. The stock of New River Pharmaceuticals Inc., based in Radford, Virginia, fell 6.3 percent after its $33.6 million IPO on Aug. 5.

The underwriting banks' clients benefited from the rise of Google's share price, says Chad Waite, partner at Kirkland, Washington-based OVP Venture Partners, which has taken 20 companies public.

``Morgan Stanley and CSFB wanted to price it at $85 and the people who got the stock allocations got the pop,'' says Waite, 49. ``Mostly, the two firms' biggest clients got to sell out at a profit.'' Waite was a partner at Hambrecht's previous firm, Hambrecht & Quist Group, from 1983 to 1987.

Banks Kept Control

Dutch auctions, according to proponents such as Hambrecht, are designed to gauge the demand for shares among both small and large investors, while reaching a price close to the stock's actual market value.

Potential buyers in an auction -- usually including small, private investors -- bid for a specific number of shares at a specific price within a range set by Google. The bids are collated by the auction managers to calculate the lowest price at which all shares in the offering can be sold, called the settlement price. Winning bidders are those whose offers met that price. If there are more buyers than available shares, the earliest bidders meeting the price receive shares.

In Google's auction, investors were permitted to submit bids at more than one price. They could bid by Internet, fax or phone after registering and receiving an identification number.

Google's offering, Hambrecht says, resembled the conventional IPO process called book building. In that process, underwriting banks gauge demand in discussions with institutional investment managers and wealthy investors.

`A Fair Process'

The banks then set a price range, based on the interest of those potential investors, that is often below the stock's actual market value. That allows banking clients to profit when shares begin trading.

The underwriting banks retain control of information about which investors bought how many shares.

In Google's IPO, only CSFB and Morgan Stanley saw all the bids from the institutional investors, says Hambrecht. As the leading underwriters, the two banks worked directly with Google executives to organize the IPO, accompanied them at their meetings with investors and collated all the bids.

Google announced the offering April 29 in a filing with the U.S. Securities and Exchange Commission, setting the stage for the biggest test of an auction IPO.

``It is important for us to have a fair process for our IPO that is inclusive of both small and large investors,'' Page and Brin said in the filing.

$135 Per Share

After announcing a proposed price range for its shares in July, Google lowered that range and the number of shares it would sell, without saying why.

In an SEC filing July 26, Google proposed pricing its shares between $108 and $135. In a filing Aug. 18, Google said it was lowering that target to a range of $85 to $95, and then accepted an offering price of $85 while reducing the number of shares sold to 22.54 million from 32.5 million.

Hambrecht says the bid totals, or ``stacks,'' from his firm's clients ranged up to $120 per share.

``Before they announced the price reduction, our bid stack predicted the stock would sell between $110 and $120,'' Hambrecht says. ``After the price reduction, the mean of our bid stack was $97. Our bid stack clearly showed that the price could have been higher.''

One of Hambrecht's clients, Richard Abraham of Havertown, Pennsylvania, says he bid as much as $100.

`Intentionally Underpriced'

``Google intentionally underpriced its stock compared to the true auction price,'' says Abraham, 48. ``I bid for a total of 1,000 shares and bid for 800 shares at $85 or higher.'' He finally received 593 shares at $85, he says, and sold them for $100 on the first day of trading.

Google would have received higher bids if its registration process hadn't discouraged some investors, says Jay Ritter, a professor of finance at the University of Florida in Gainesville who advised Google on its IPO.

``It was a tactical mistake to revise down the IPO price one day before the stock began trading and after the registration process closed,'' says Ritter.

Hambrecht says the offering achieved Google's objectives even though it was underpriced, because the auction allowed customers and other small investors to buy shares.

``It was never their objective to get the highest price,'' says Hambrecht. ``The company is awash with cash. They wanted marketability. They wanted access to their customer base.''

To contact the reporter on this story: Brett Cole in New York coleb@bloomberg.net

Last Updated: October 19, 2004 00:12 EDT