Ronna Abramson

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Google IPO an Unlikely Lifeline for Technology

Ronna Abramson

The love affair with Google's IPO seems to be coming to a rocky end, dashing hopes that the public offering would spark a similar love fest in the embattled tech sector.

Early on, some industry optimists cast the highflying search engine as the next Netscape that would herald a new era of tech investing. But that sentiment has cooled as the IPO has lost some of its luster. Particularly in the past couple of weeks, investors have been grousing about the IPO's proposed $100-plus price tag and the timing of the offering during the August doldrums, when most of Wall Street takes a summer vacation.

Tech experts say that the company's public debut is more likely to only marginally build momentum for others to go public -- and that's assuming its unconventional Dutch auction goes smoothly.

"I think a lot of people are hoping that Google creates some demand in tech, especially for some of these smaller IPOs, but I think the biggest determinant of market success for IPOs is just the market itself," said Tom Holman, a portfolio manager for Evergreen Funds. And "the market has not been very cooperative ... for IPOs."

Coming-Out Party

That's not immediately obvious from the sheer volume of IPOs this year. Although the Nasdaq is down about 10% since the beginning of the year and nearly 16% down from its 52-week high, 137 companies have gone public this year, far exceeding the 86 IPOs in 2003 and the 95 in 2002. On those numbers alone, "the [IPO] market is flying," says John Fitzgibbon, editor of IPO Web site 123jump.com.

But it's flying a little lower than earlier this year, much like the stock market. "It's been a great year" for IPOs, said a technology-focused investment banker, who asked to remain anonymous. But "[the IPO market] is certainly not as buoyant as it was two months ago."

One symptom of the declining health of the IPO market is the recent rash of discounting on offering prices. More than one-third of the companies that have gone public this year have trimmed their offering price from their initial range, while only 17 companies priced above that range, according to Thomson Financial.

The reason for the discounting is because "there's a lot of inventory out there. Plus the market has been going sideways," said Richard Peterson, a market strategist for Thomson who focuses on IPOs, and mergers and acquisitions.

The large inventory means investors can pick and choose which IPOs they want to participate in. "We're looking for companies that are profitable or very close to being there, in a defensible niche," Holman said.

"A lot of these companies that we're looking at, while they've improved dramatically over what we saw in the late '90s in terms of the quality and where they're at in their life cycle, they're just not as compelling as some of the things that are more seasoned in the marketplace," Holman said. "I think that's why they're struggling a bit."

In addition, the majority of IPOs this year haven't exactly fared well. More than half are now trading lower than their offering price, losing on average 3.5% this year, according to Thomson.

And in yet another sign of the IPO market's health taking a turn for the worse, seven companies withdrew or postponed their offerings last week, according to Thomson. One of those companies, Nanosys, an early-stage nanotech company that proposed raising roughly $100 million, cited "the volatility of the public capital markets" for its withdrawal.

Unfortunately, One of a Kind

Google, of course, stands out for its broad brand awareness, impressive top line (at $961.9 million in 2003) and strong profits, at $105.6 million. For those reasons alone, Google is an anomaly, and consequently its IPO performance isn't expected to be a catalyst for other tech stocks, IPO watchers say.

"I don't know whether you're going to have heavy coattails," said Sal Morreale, who tracks IPOs for Cantor Fitzgerald in Los Angeles. "Wall Street is more concerned with [each individual company's] balance sheets, good management."

"We're not anywhere back to the go-go days," he added.

If anything, Google just "enhances the public's interest in technology investing in general," all the way down to angel investors, said Jonathan Silver, a venture capitalist with Core Capital Partners.

"It demonstrates that technology companies can be large and profitable and high growth, even in a mixed market and a mixed economic environment," Silver added. "I don't know that it makes it easier or harder for that matter for companies that have not yet filed."

Paul Koontz, a general partner at Foundation Capital and the first vice president of marketing at Netscape Communications, noted some important distinctions between Google and companies such as Netscape and Cisco (CSCO Quote) that stimulated a broader market.

"The Netscape IPO signaled an entirely new category and really educated the common investor on the prospects the Internet held for them," Koontz said. "Google is plugging into an existing infrastructure ... Everyone knows the Internet now."

Make Us an Offer

Google's Dutch auction is another anomaly that could limit the offering's spillover effect on the broader IPO market. The company's controversial price range of $108 to $135 per share suggests there's more downside risk after the stock begins trading in the open market, many industry observers argue.

Under the Dutch-auction model, the offering price should reflect the value investors are willing to pay for the stock and, consequently, it shouldn't enjoy a big moonshot once it's publicly traded.

But David Menlow, president of IPOfinancial.com, still believes that even if investors understand that, the Dutch auction poses some problems. "I think in the lack of advancement of the stock in the aftermarket, it becomes a sitting target for short-sellers," he said. "With that having been said, I don't view the Dutch-auction process as a viable platform for success stories in the IPO market."

On the other hand, if he is wrong, "a successful deal should bring more [companies] out of the woodwork as far as issuers," Menlow acknowledged.

But one premise of Menlow's bleak outlook -- that all the buzz around Google is going to push institutional investors onto the sidelines -- may prove false. Despite recent news reports about many investors sitting this IPO out, attendance at recent roadshows and interviews with some institutional investors tell a different story.

A roadshow held by Google two weeks ago at the Waldorf Astoria in New York City attracted about 700 institutional investors, estimated Alan Loewenstein, co-portfolio manager of the John Hancock Technology Fund. "We talked to the lead underwriters -- Morgan and First Boston -- and we can make a bid like everybody else, which we do plan on doing," Loewenstein said.

He said he was undeterred by the rich price range, noting that it doesn't matter if his fund is trying to build a specific overall position. If a stock is $20 instead of $100, it just means buying five times as much at the lower price to build that position, he explained.

Another institutional investor, Transamerica Investment Management fund manager Chris Bonavico, who attended the roadshow at San Francisco's Four Seasons hotel last week, said he hasn't been turned off by Google's pricing guidance because he figures he can still bid lower.

"I do think the high end of the range is too high for my taste for the risk, and moving [the company's market value] $35 billion north takes an awful lot of free cash flow," said Bonavico, who estimated the San Francisco roadshow attracted about 200 people.

But "there is a price at which it becomes interesting because I believe Internet advertising, especially search-based advertising, is a very big market," Bonavico added, declining to comment on whether he will definitely submit a bid for Google shares. "I think just to say, 'Stay away, period. End of sentence,' is wrong."