Should you buy
With its stock auction set to close in the next few days (if the company can get all of the glitches out of its auction system), you don't have much time to make up your mind.
You have to answer two questions before taking the plunge.
First, is buying Google shares in its initial public offering a reasonable speculation? Here a trader is betting that this will turn into a hot technology IPO. Buy now and quickly flip the shares for a comfortable profit.
Second, is buying Google at the IPO a good investment? Here an investor is looking to buy a piece of the long-term future of a potentially great company. Bid the right price at the auction and hold on for appreciation over the long haul.
A resounding "no" is the answer to the first question. The odds are heavily against the Google IPO making a flipper's dreams come true.
Answering the second question takes more work and some number-crunching. On the fundamentals, the answer is "Maybe -- at the right price." The odds are that investors will have a better chance of finding that right price after the IPO.
Why Google Will Disappoint Traders
So why don't I think this is a trader's IPO? For the simple reason that Google has stacked the deck against traders.
The unusual auction format the company is employing to sell its stock is designed to get the company the best price for its shares and to leave as little money as possible on the table. If demand runs hot, Google can simply increase the number of shares allocated in the offering. That could eliminate the kind of pent-up demand from investors shut out of a hot IPO that in the past has turned high-profile deals into stock market rockets.
And then there's the unusually short "lockup" period before company insiders and existing investors can sell shares on the public market. Generally speaking, company insiders are barred from selling their stock within the first six months of an IPO. Limiting insider stock sales helps prop up the price of the shares. Savvy IPO traders, in fact, know to sell before the lockup expires, releasing a flood of new shares onto the market.
The Google lockup expires unusually quickly. After 15 days, an additional 4.6 million shares are eligible for sale. After 90 days, an additional 38.5 million shares are eligible for sale. That's 43.1 million shares, or almost twice the 24.6 million shares Google will sell in its IPO. That potential supply will quickly satisfy any hunger for extra shares that may exist after the IPO.
In short, there's so much supply -- and so little unsatisfied demand -- hanging over this IPO that it will be very, very tough for shares to rocket higher after the IPO. As Google points out in its prospectus, the odds are the shares will drop in price after the IPO. At least initially.
The Price Is Not Right
But what about Google as an investment instead of a speculation?
Here, too, Google has stacked the deck, I believe, by setting share price too high.
At the company's announced price range for the IPO of $108 to $135 a share, the company is setting a value on itself of $29 billion to $36 billion.
That's a nice price if you can get it, considering
, a more established company with a long track record as a public company, currently commands a market value of just $36 billion. And that's after a turnaround in the Internet advertising business has sent Yahoo!'s stock up 212% in the last three years.
Many Wall Street analysts believe Google arrived at its valuation by using Yahoo! as a model. It's not an outlandish comparison.
In the first six months of 2004, Google grew revenue by 163% to $1.35 billion. Yahoo! grew revenue by 142% to $1.59 billion. (Google recently changed its methods for accounting for revenue to match those that Yahoo! uses. Both companies use gross revenue, which includes payments they make to third-party advertising partners for ads Google and Yahoo! place on their sites. Prior to the IPO prospectus, Google used net revenue, which doesn't include those fees.)
Google trailed Yahoo! for that six-month period in profitability. Net profit margin at Google for that period was 10.6%. For Yahoo!, it was 14%. But it outdid Yahoo! in earnings growth. In the first six months of 2004, Google grew earnings per share by 111%. Yahoo!'s earnings climbed by 88%.
Discounting the Offering
But investors thinking about the Google IPO need to remember that this kind of valuation calculation isn't finished when you find a roughly comparable company. Investors still need to ask two more questions.
First, so what if Google matches up with Yahoo!? All that may prove is that both stocks are overvalued. Yahoo! currently trades at 103 times trailing 12-month earnings. That's pretty steep when stocks in the
are trading at 19.5 times trailing 12-month earnings.
Other ratios for Yahoo! are also way ahead of the rest of the stock market. Yahoo!'s price-to-cash-flow ratio, for example, is a heady 74.4 when the S&P 500 ratio is just 11.9. (That price-to-cash-flow ratio would be even higher and Yahoo! would look even more expensive except for cash flow from a tax benefit to the company from employees who exercised stock options. That accounted for about 24% of second-quarter cash flow.)
So the top of Google's range at $135 a share is only a reasonable valuation if you'd be willing to buy Yahoo! at its recent price. For my tastes, Yahoo!'s recent decline has further to go before the stock is attractively priced. If Yahoo! fell another 15% or so from here, I'd start to get interested. So I see no reason to pay a price for Google that I'm not willing to pay for Yahoo!.
And what about a discount in Google's price for all the ways it doesn't match up with Yahoo!? Yahoo! has been public since 1996, survived the Internet bubble and made the transition from a company run by the founding entrepreneurs to one run by professional managers. And we know that Yahoo! knows how to navigate the ever-changing technology trends. This is one tough competitor.
And Google? Well, it's still run by its founders and it still has that wrenching transition from that team to its successors ahead of it. Many successful start-ups don't survive that move.
And Google's founders have made the transition tougher by cementing themselves in power: The company is selling A shares; the founders will have B shares that carry 10 times the voting power. After the offering, company officers and directors will control 60% of the voting power. Nothing in the way that founders Sergey Brin and Larry Page have handled this IPO and Google's relationship with Wall Street convinces me that they have the finesse required to run a public company.
Google's very success is attracting a host of competitors, among them Yahoo! and
, two very tough opponents. Yahoo! already has beefed up its search technology, and Microsoft is set to launch a new search technology in late 2004 or 2005. And don't forget the next wave of search companies, just now rolling out of garages all over the U.S. For instance, there's IceRocket in Dallas, with an investment from Dallas Mavericks owner Mark Cuban. Meeting all of those competitive challenges will drive up Google's capital spending, the company admits, which will take a bite out of that 10.6% net profit margin.
It's also important to remember that Google is more of an advertising company than a technology company. Sure, technology drives its search engine, but it's the growth rate of Internet advertising that will drive the speed of Google's own growth.
And then there's the rescission issue. The company violated state and federal security laws by failing to properly qualify a number of options. The company says it intends to correct the problem by purchasing the options at a cost of about $26 million.
It's not the money that bothers me, but the sloppiness this suggests.
To me, this suggests a further 20% discount for Google's youth and immaturity.
Add the two discounts together: 15% off the top of $135 for the Yahoo! discount takes the price I'd bid to $114.75. And take 20% off that for the youth discount and the price I'd bid comes in at $92 a share.
Left to my own calculations, that's what I'd bid for Google's shares. It's about 15% below the $108 per share bottom of the range that Google anticipates receiving in the offer, but as the prospectus says, "Bids may be within, above or below the estimated price range."
Updates to Jubak's Picks
The selloff in the market has shifted the risk/reward outlook for the next six months. I'd like to raise some capital to take advantage of the opportunities that should come along later this year.
is within 10% of my target price and has held up well in this decline: I think the stock is still a good bet to hit that September target. But the selloff is creating buying opportunities -- although I think it's too soon to bite on any of them -- that are likely to return much more than that. I'd like to be ready with some cash when the time is right. I have a 7% return on Bunge since I added it to Jubak's Picks at $37.59 on Feb. 17, 2004. Investors with time horizons longer than the 12 to 18 months I use in Jubak's Picks should feel free to ignore this sell and just hold onto this blue-chip food stock.
At the time of publication, Jim Jubak owned or controlled shares in none of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column. Email Jubak at