TCS Daily

Street Fight

By Andy Kessler - May 7, 2004 12:00 AM

Gotta love it. Two 30 year olds, armed only with Lava lamps and 100,000 cheap PCs spitting out Google searches, are flipping the proverbial bird to blue-blood suspender-wearing Wall Street. And why not? Google is the most profitable company I have ever seen. Their 60% operating margins make Microsoft look like pikers. There are certain unwritten rules for structuring a tech company and filing for an initial public offering and Google just broke them all.

Start with new age Google's S-1 document filed with the depression-era Securities and Exchange Commission. It opens with a Warren Buffet-esque breezy letter, "AN OWNER'S MANUAL" FOR GOOGLE'S SHAREHOLDERS by founders Larry Page and Sergey Brin. Fair enough. But henceforth and forthwith in this highly legal document, ipso facto, they are known as Larry and Sergey. How quaint. There is also a mission statement that states "Do No Evil." Commendable. Good show. Peace and love, dudes.

But investors invest in companies to generate returns and an IPO prospectus is a great place to make your pitch. Lar and Serge don't bother. Instead, they just say, "Trust me." Trust me? This is dog-eat-dog Wall Street.

The founders claimed the title of co-Presidents with 48 year old Eric Schmidt as CEO. Exactly who makes decisions? Not to worry, I notice the outside directors representing the public's interests on the board looks pretty good, including Stanford University President John Hennessy and Intel President Paul Otellini. Well, maybe not. There is this tiny slap in the face: public shareholders will get Class A shares with one vote while insiders get Class B shares with 10 votes each. It only takes a simple majority to remove a director. Some shareholders, it seems, are more equal than others. Did these guys take hubris lessons from Ted Turner? Like Warren Buffet's company, this is no corporate governance haven.

The other thing shareholders won't get is much help in figuring out how the company is doing. Google is famous for their secrecy and going public won't change much. The public will get no earnings guidance from Google. Just guess and they'll tell you if you are right once a quarter. You'll have to ask analysts like Mary Meeker at Morgan Stanley for advice.

"But who cares, this is going to be the hottest IPO since, well, since, right?" Not so fast. To get the business, and the largest chunk of the $80 million in underwriting fees, Morgan Stanley had to agree to a Dutch auction. You know, the auction method the Dutch use to sell flowers at the price that clears out all the flowers in stock, tulip bulbs inclusive.

Larry and Sergey apparently were adamant for a fair price that didn't move up or down much from where it is sold and a wide distribution of shares (will 50 million investors each get one share?), so they insisted on an auction. I hope they know what they are doing. IPO auctions have been tried by other countries for the last 20 years and mostly abandoned. Street rumors are swirling that Goldman Sachs was in the running until their CEO blew a gasket bad-mouthing IPO auctions. We'll see who is wiser.

Auctions break a cardinal rule of Wall Street: Everybody gets paid. Bankers get 7%, venture capitalists get a liquid market to dump shares into, but with auctions, no one is paying investors for the risk of owning shares that never traded before. Before you say, boo-hoo, remember that companies come and go, but capitalism still runs the same way. Money chases returns. The trillions sitting in mutual funds don't invest in companies because they have a cool website. Even high margins can be fleeting. Fidelity can very well decide to sit out this deal by putting in a low bid or not bidding at all. A buyer's strike is certainly possible, as is a deal that, gulp, trades down on the its first day.

"But still, c'mon, these guys are doubling sales every year. They are practically printing money with their profits." Sure, I agree. It's a great company, but ... what goes around comes around, ask Netscape. A huge IPO in 1995 and all it took was some bad acquisitions and one soft quarter for investors to flee and that train to derail.

Mr. Brin and Mr. Page might be two of the smartest guys in the Valley, but 30 year olds may not understand the importance of public shareholders in Google's long-term success. A rising stock price and stock options are critical in recruiting great talent. Microsoft has a heck of a time hiring
when their stock stalls.

Plus technology moves at gigahertz speed. Today's 60% margin business is tomorrow's commodity. A vibrant stock and great long term shareholders are key to using stock as a currency to buy other companies and technologies that Google will certainly need. And soon. Silicon Valley is a high stakes game. Google has spent $258 million on information technology to put together their search network. That's a rounding error at Microsoft. Guys like Yahoo, Ebay, Amazon, and heck, even TimeWarner/AOL (remember them?) are trying to take Google out.

Fourteen different startups I know of can become formidable competitors quickly. Don't get me wrong, Wall Street needed a thumb in its eye for the crony capitalism it practiced in the '90's. But Google is going to need Wall Street more than Wall Street needs Google. Trust me.

Andy Kessler is the author of Wall Street Meat.


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