Sometimes it pays to break the rules

Benj Gallander and Ben Stadelmann
Friday, June 10, 2005

As corporate slogans go, Google’s “Don’t be evil” has to be one of the most unusual. Though most consumers would consider the ubiquitous search engine to be a godsend, one group would deem it more diabolical than Beelzebub and Darth Vader rolled into one. For the financial “establishment” on Wall Street, Google’s emergence as a public company has been a wicked road of woe.

It wasn’t supposed to be like this. A couple of years ago, the prospect of this monster initial public offering, and the delicious fees it would generate for those bringing it to market, made investment bankers slaver with anticipation. However when Google refused to follow the orthodox script and chose a “Dutch auction” to allocate shares, the ardour was replaced with seething anger.

In a nanosecond, founders Sergey Brin and Larry Page went from being wunderkinds to btes noires. The media teemed with articles highlighting the entry of Microsoft and Yahoo into Google’s turf. The company’s prospectus was openly mocked; what do these bozos need washing machines in their offices for, anyway?

Some brokers, like Merrill Lynch, pulled out altogether; others complained that extra software costs were eating into the already-miserly commissions. Institutional Shareholder Services, which has grown powerful in the Sarbanes-Oxley age, gave the company a rock-bottom “corporate governance quotient” of 0.2 out of a possible 100. Ouch! Why didn’t they just round it to zero?

It wasn’t just the auction that rankled professionals. At every turn the Google team refused to play the game by Wall Street’s rules and acted, well, contrarian. The language in the prospectus avoided the soothing tones of typical IPOs and instead emulated the straight talk of a Warren Buffett homily. Analysts found out that the company wouldn’t be issuing quarterly guidance for revenue and profits. On the road show, executives refused to fawn and answered questions with a clipped “No comment.”

The infamous Playboy interview invited a US Securities and Exchange Commission review, although backroom banter suggested that regulators were interested in more than the articles. The “lockup” agreements governing when insiders could sell more shares were unusually generous.

Even the timing of the IPO was considered idiotic, in mid-August, when the movers and shakers are hanging out in the Hamptons. As one portfolio manager succinctly put it, “Google broke all 10 commandments of a successful IPO.”

The Street’s cold shoulder was effective. When the number of shares to be sold was sharply reduced, Wall Street felt vindicated and the media squealed in derision. A sample of the headlines: Newsweek, “Surviving the IPO from Hell”; Forbes, “Google’s Flub, Flop and Bomb”; and, predictably, from the Wall Street Journal, “Engine Trouble: How Miscalculations and Hubris Hobbled Celebrated Google IPO.”

Academia fired its shots. Tom Taulli, a finance professor at the University of Southern California, while acknowledging the founders’ smarts in technology, opined: “These skills do not translate well to the tricky business of raising billions of dollars. This is something that should be left to the pros.”

He predicted that once the IPO came to market, “First, hedge funds and short-sellers will have their way with it, selling it off to bargain hunters who eschewed the auction. If you’re a retail investor playing with professionals, you’ll get crushed.”

Well, now, let’s see who crushed whom. For starters, the company did well in the IPO, raising $1.67 billion (US), with about $50 million in fees, less than half the going rate of 7 percent that is normally sucked up in commissions. As Google’s stock climbed during the first few months of trading, analysts kept pointing to the expiration of lockup agreements when millions of more shares would become available on the market. And sell they did.

Google co-founder Larry Page cashed in 1.2 million shares in March for a cool $213 million. In all, insiders have sold over $2 billion worth of shares. But the stock just kept going up.

By being “forced” to reduce the original number of shares to be sold, insiders did far better. People who bought the stock in the auction process at $85 have also made out like bandits. For institutional investors it’s been a nightmare — everybody is making money hand over fist except them.

As for the “smart money” that had the temerity to short the stock, javelin catching seems like a safe sport by comparison.

The worst is yet to come. With the stock flirting with the $300 mark and a market capitalization of over $80 billion, Google is now the most valuable media company on the planet. Despite its maverick ways, it is inevitable that the company will join the S&P 500.

When that happens, portfolio managers will be faced with a grisly dilemma: either swallow their venom and buy the stock at over three times the price they could have paid during the IPO, or risk being outperformed by the benchmark. You can bet drycleaners are doing a good business!

We don't own Google ourselves, but we can still appreciate how a couple of “amateurs” have wiped the floor with the pros.