Googling Future With Ghost of IPOs Past

Editor's Note: This marks the debut column of Aaron Pressman, senior market columnist. He most recently wrote about mutual funds, including the latest scandals, for Bloomberg News in Boston. Before that, he worked at publications ranging from The Bond Buyer to The Industry Standard. His past beats include IPOs, bond trading, derivatives and banking regulation. We welcome your feedback.

Google's much-anticipated IPO guidance announcement Monday sparked a heated debate over the Internet search engine's valuation. Predictably, Google is being compared with current Internet bellwethers but the hyperbole also recalls the 1990 initial public offering of another California technology company started by a pair of Stanford University alumni: Cisco Systems ( CSCO).

The brain-child of Stanford University grad students Larry Page and Sergey Brin, Mountain View, Calif. Google said it expected to raise as much as $3.3 billion, or $135 a share, at the IPO before paying underwriting fees. That would give the company a stock market value of over $36 billion.

The value approaches Yahoo's ( YHOO) $38 billion market capitalization and, as many pundits noted, is slightly more than that of McDonald's ( MCD). Unmentioned in such facile comparisons is McDonald's $9.1 billion in long-term debt, as of March 31, compared to Google's all-equity balance sheet.

Many observers were quick to heap scorn on Google's projected pricing range. One pundit said the stock could fall 50% within days of the IPO and a fund manager cited by Reuters said Google was priced for perfection -- setting investors up to get hammered. Pessimists think Google is in a commodity business about to be overtaken by Microsoft ( MSFT).

Bill Miller, manager of the ( LMVTX) Legg Mason Value Trust fund, disagrees. The man who has beaten the S&P 500 for an unprecedented 13 years in a row has said he'll be a bidder at the IPO's unusual Dutch auction, but hasn't disclosed his price.

"Google's a much different business than just a search business," Miller told reporters during a briefing at Legg Mason's Baltimore headquarters on May 26. "And even if it is, I can see what their cash flow is doing right now," he said pointing an arm towards the ceiling.

Google hasn't included a cash flow statement in its Securities and Exchange Commission filings yet, but cash and short-term investments on its balance sheet increased by more than $200 million to $549 million in the first half of this year -- about 15% of revenue and almost 50% more than total net income for the six months.

Miller said the company ought to be worth somewhere between Amazon.com ( AMZN) and eBay ( EBAY). Legg Mason is the largest outside investor in Amazon and among the top-10 owners of eBay.

Since 2001, revenue at Google has grown almost twentyfold from $86 million in 2001 to $1.5 billion last year. In the first six months of 2004, revenue increased 141% to $1.4 billion and net income jumped 147% to $143 million.

While Internet bellwethers Yahoo, eBay and Amazon.com all earned more during the six-month period, none saw profits grow as fast.

IPO Memories

Google's announcement Monday brought me back almost 15 years when, as a cub writer for a newsletter called IPO Reporter, I followed a similar valuation debate over a tiny company with revenue of less than $50 million. Some said the company, known then as cisco Systems with a lower-case "c," was going to dominate the fast-growing market to supply corporate computer networking gear. Others complained it was an overpriced, overhyped sucker's bet.

Priced at $18.50 in February 1990, Cisco ended the year above $40 and didn't look back. Originally a play on the growth of computer networks within offices, the company experienced its greatest growth from the late 1990's Internet boom, when customers bought switches and routers to connect to the Web and expand the reach of connections across the globe.

In fact, if I'd invested my modest monthly paycheck in Cisco's IPO instead of writing about the debut, I'd have made more than $1 million within 10 years. Even after the Internet bubble popped, I'd be left with $250,000 on a $1,000 investment.

Google founders Page and Brin aren't planning to sell any hardware to rewire the Internet. And even that (arguably) revolutionary business has slowed dramatically -- witness Cisco's swoon from over $80 a share to Monday's close of $20.54. Of course, Google doesn't have to approach the $300 billion Cisco was worth at its height to validate its projected $36 billion IPO value.

Instead, Google's software and search services have become a virtual fixture for people trying to find information amidst billions of Web sites. And the company is offering an expanding array of services like the new "gmail" email service to attract a bigger audience for the targeted advertisements that bring in most of Google's revenue.

Like Cisco co-founders Len Bosack and Sandy Lerner, Page and Brin have brought in more experienced managers to run their Stanford spin-off. Google's IPO plans took form under the direction of chairman and CEO Eric Schmidt, who joined in 2001 after a stint running Novell ( NOVL).

To be sure, buying shares at an IPO can be a risky endeavor. Who can forget the millions of average AT&T ( T) employees clamoring to get a piece of the company's April 2000 spin-off of AT&T Wireless ( AWE) at the "bargain" IPO price of $29.50. The shares dropped within days and traded for under $5 less than three years later.

Even after AT&T accepted this year's acquisition offer from Cingular, the shares have lost more than half their value from the IPO, while the S&P 500 is down less than 30%.

As many savvy value investors know, IPO shares often take a dive 180 days after being priced when so-called lockup agreements that bar insiders from unloading shares expire. Google said yesterday that 38.5 million shares would be eligible for sale on the open market after 90 days and 170.8 million after 180 days.

This is my inaugural column for TheStreet.com. As may be obvious from my take on the upcoming search engine IPO, I'm a contrarian by nature. If it sounds too good to be true, it usually is. But if everybody says it's too good to be true, I'm suspicious. Going forward, I'll seek to uncover and go beyond the conventional wisdom to explain what's driving the financial markets, sectors within the equity market or even specific stocks.

Take it all with a grain of salt: After all, I didn't buy any shares of cisco Systems with a lower case "c."

In keeping with TSC's editorial policy, Pressman doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback.

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