4.3.3 Google: success story or a bubble yet to burst?
The internet search engine company Google, established in 1998, adopted a very different approach to their IPO on the NASDAQ stock exchange in August 2004.
Controversy accompanied the run-up to the launch, with Google encountering problems with SEC regulations for public offerings by issuing shares to staff prematurely and by talking about the issue to Playboy magazine. The company also declined to market the issue of shares by road-showing it to potential investors – something that is commonplace when companies enter a market for the first time. The greatest interest, however, focused on Google’s approach to pricing their IPO: they decided to use a Dutch auction to allocate the shares. With this method, shares are distributed to investors whose bids are at or above the price that sells all the shares available. In effect, Google was asking investors to say what they thought was the right price for the shares, rather than vice versa. In theory, this method should mean that at launch the issuer extracts the maximum proceeds possible. Did this work?
After a late decision to cut the number of shares offered from 25.7 million to 19.6 million, Google set a price range of $85–95 (below the range previously indicated). The Dutch auction allocated the shares at $85 – the base of the indicated range, but once the shares started trading their price rose above $100 and after three months they were trading above $169. This was not entirely surprising since the Dutch auction appears to have been flawed: at $85 there was unmet demand for Google’s issue of shares, with one quarter of the bids for shares being unsuccessful. Despite the fact that equity markets were on the upturn in autumn 2004, it appears that Google underpriced its IPO. The complexity of the Dutch auction may have deterred investors from bidding for shares at the launch, thereby constraining the issue price.
The conventional process of marketing and book building would almost certainly have yielded the company more from its IPO, but Google is anything but a ‘conventional’ company. In addition to providing an interesting case study of an IPO, the subsequent sharp rise in Google’s share price prompted – not for the first time – interesting questions about the valuation of a technology company. Indeed, valuing young technology-based companies with a short financial history that operate in a rapidly changing business environment is always a challenge.
Shortly after the issue, Allan Sloan of the Washington Post wrote:
The stock market is valuing Google at almost $30 billion, or almost 87 times the $1.26 per share profit it reported for the 12 months ended June 30 [2004]. Google earned $7 million on $86 million in revenue in 2001, its first profitable year, and $191 million on revenue of $2.26 billion in the 12 months ended June 30. But the company’s not a small start-up anymore. To keep up this growth rate, Google will have to earn $5 billion on revenue of $60 billion in 2006. That’s clearly not going to happen
Sloan’s prediction was proved correct: Google made $3.1 billion in net income on revenues of $10.6 billion in 2006. Despite this, Google has continued to be a high profile corporate success story. In July 2011, it announced net income of $4.3 billion on revenue of $17.6 billion for just the first six months of 2011. The surge in its share price had resulted in Google becoming the world’s largest media company.
At the time of writing (2015) Google shares are now trading at $537 not far below its all-time high of $608. In fact, given a restructuring in 2014, which saw each of Google’s existing shares replaced by two new shares, the prevailing price effectively represents close to a 12 ½ -fold increase over the issue price.
So is Google a secure stock or a large, long term bubble?