By Scott Kessler
As part of what we consider one of the most unique initial public offerings in recent memory, Internet search leader Google is employing a Dutch auction to sell its shares. Essentially, would-be investors are bidding to purchase the shares. We believe this type of auction has never been used for such a large and prominent stock offering in the U.S., although it has been employed for various debt and international equity offerings.
Because of the novelty of the process by which Google will sell its shares, we've set out to detail how the Dutch auction will work, the risks associated with it, and what we think would-be investors in the IPO should do.
(Editor's Note: This article is an excerpt from Part 2 of S&P's Google Pre-IPO report. Full .pdf versions of Part 2, as well as Part 1 and the Search Engine Survey conducted for S&P, can be purchased directly at http://sandp.ecnext.com/ipo (Adobe Acrobat is required). Additional information on Standard & Poor's pre-IPO coverage on Google can be found at http://www.standardandpoors.com/pre-ipo)
WHAT BIDS INCLUDE.
The auction process, which began on July 30 and was still underway as of Aug. 9, will be conducted in five stages: Qualification, Bidding, Auction Closing, Pricing, and Allocation.
Qualification requires registration for a bidder ID at www.ipo.google.com, which became operational on July 30. Google has indicated that this Web site may be open for obtaining bidder IDs for only one week. Bidder IDs will not be available once bidding begins.
Once the auction starts, those who have qualified can submit bids through one of the 28 underwriters. A bid must include a desired number of shares, a contemplated per-share purchase price, and additional information as needed by the underwriter (to identify and confirm eligibility and suitability for participating in the IPO, and for sale consummation).
Bids may be within, above, or below the estimated price range indicated by the company of $108 to $135 per share. Bid prices may be in any increment, including pennies. The minimum size of any bid is five shares. More than one bid can be submitted per bidder ID. Each underwriter can receive bids through one of more of the following means: over the Internet, by telephone, by fax, or in person. To participate in the auction, would-be investors must agree to accept electronic delivery of certain Google SEC filings.
UNCERTAIN CLOSING TIME.
During the bidding process, Google and its managing underwriters will monitor the master order book to evaluate demand. Based on this information and other factors, they may revise the price range, and could decide to change the number of shares offered (which would likely increase if the price range increases).
A bid would have to be reconfirmed if more than 15 days have elapsed since submission, or the prospectus changes materially. If reconfirmation is required, electronic notification will be sent. If prior to the registration statement becoming effective, the expected price range or number of shares changes in a manner that is not otherwise material to the offering, notice will be provided on Google's IPO Web site, via press release, and electronically.
The auction can close at any time. Once it ends, bid modifications and withdrawals are not possible. When the registration statement becomes effective, associated electronic notifications will be disseminated indicating that successful bids could be accepted in as little as one hour. Accepted bids will obligate purchase of allocated shares.
Google expects to disclose a clearing price for the shares, which will be the highest price at which all of the stock is offered. The IPO price will be determined by Google and its underwriters after the auction closes, and will likely be equal to the clearing price. The IPO price could be lower than the clearing price. By Scott Kessler
If the IPO price is between $108 and $162, the underwriters can accept all bids by sending electronic notices. If the price falls outside this range, notice will be provided of the final offering price and bids could be accepted within one hour thereafter.
All investors submitting successful bids will receive an allocation of shares sold at the IPO price. If the price equals the auction-clearing price, successful bidders will be offered shares comparable to their bid amounts. If the number of shares represented by successful bids exceeds the number of shares offered, Google intends to allocate at least 80% of the stock contemplated.
We believe there are several risks to the Dutch auction being employed by Google. Primary among them, in our opinion, is a potential lack of demand for the shares. We believe many institutional investors will opt not to participate in the IPO, reflecting uncertainty as well as perhaps to rebuke the Dutch-auction process the company is employing. We also think individual investors could be put off by the high anticipated IPO price and the requirement to buy a minimum of five shares. Moreover, we consider the auction process somewhat complicated and time-consuming, perhaps dissuading would-be investors.
Seasonality, potential significant major news events (that could serve as distractions), and the recent unfavorable climate for technology and Internet stocks could also negatively impact the Google IPO's prospects, in our view.
We expect much of the investment community will not participate in the IPO process, owing to these risks. Moreover, with the most aggressive auction bidders more than likely receiving full-share allocations, early after-market demand could be lacking, in our view.
Thus, notwithstanding our assessment of Google's potential per-share valuation, we believe the Dutch-auction process could have a substantial negative impact on the stock, and recommend would-be investors be particularly prudent.
We believe that even though the IPO price range of $108 to $135 per share indicated by Google is reasonable based on a variety of valuation methodologies, risks related to the Dutch-auction process and other factors are material. Google could possibly be priced and trade below the company's indicated range and our assessment of its possible valuation of $121 to $127.
What, then, should would-be investors in Google's IPO do? We advise them to bid $110 for each desired share. This would imply 10% upside to the low end of our estimated fair market value range ($121). (See BW Online, 8/10/04, "Putting a Value on Google, Part 2".) We also suggest bidders not commit to full positions in the Dutch-auction process, allowing for opportunistic dollar-cost averaging if the stock falls in the first hours, days, or weeks of trading. We expect these chances to present themselves, particularly due to what we anticipate will be substantial share-price volatility.
As of June 30, 2004, SPIAS/SPSI and their U.S. research analysts have recommended 35.9% of issuers with buy ratings, 52.7% with hold ratings and 11.4% with sell ratings.
5-STARS (Buy): Total return is expected to outperform the total return of the S&P 500 Index by a wide margin, with shares rising in price on an absolute basis.
4-STARS (Accumulate): Total return is expected to outperform the total return of the S&P 500 Index, with shares rising in price on an absolute basis.
3-STARS (Hold): Total return is expected to closely approximate the total return of the S&P 500 Index, with shares generally rising in price on an absolute basis.
2-STARS (Avoid): Total return is expected to underperform the total return of the S&P 500 Index and share price is not anticipated to show a gain.
1-STARS (Sell): Total return is expected to underperform the total return of the S&P 500 Index by a wide margin, with shares falling in price on an absolute basis.
All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.
Note: Scott Kessler has not participated in, and will not participate in, the Google IPO process.
Price charts and required disclosures for all STARS-ranked companies can be found at www.spsecurities.com.
The research report from which this article was excerpted was prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS") and distributed in the U.S. by Standard & Poor's Securities, Inc. ("SPSI"), a registered broker-dealer, and a member of the New York Stock Exchange, Inc. and National Association of Securities Dealers, Inc. The research and analytical services performed by SPIAS are conducted separately from any other analytical activity of Standard & Poor's. No research analyst that prepares a research report on a subject company has a financial interest in or is associated with that subject company.
This material is based upon information that we consider to be reliable, but neither SPIAS nor its affiliates warrant its completeness or accuracy, and it should not be relied upon as such. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results.
This material is not intended as an offer or solicitation for the purchase or sale so any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.
Analyst Kessler follows Internet software and services stocks for Standard & Poor's Equity Research Services