Google's Big Splash Aided by Bid-Fill Strategy

The company appears to have filled just three-quarters of qualified bids, helping along an opening-day pop that sent shares up $15.
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Updated from Aug. 19

Here's one reason for the heavy demand for

Google's

(GOOG) - Get Report

shares Thursday: The company chose not to completely fill eligible bids in its IPO auction.

Some investors who had winning bids for more than a handful of shares were allocated 74.2% of the shares they had sought to purchase,

TheStreet.com

has learned. If that's true across the board, it suggests that Google priced its offering well below the level that bidding would have supported, helping to feed the stock's 18% surge Thursday.

To be sure, there's nothing improper about setting a low offering price that results in only partial fulfillment of winning bids. But the strategy is noteworthy because it helps give the shares a first-day pop. That run-up is one of the things the auction route is supposed to eliminate, in the quest to help reap the greatest possible proceeds for the company going public.

Shares in the search-engine company

rallied sharply in the long-awaited open of their

Nasdaq

trading. The stock jumped to $100.01 on the first trade and traded as high as $103 and change before closing at $100.34, a sharp 18% rise. Each dollar an investor in Google's IPO makes in its first day of trading, in other words, is a theoretical dollar that Google has left on the table.

The stock was up another 66 cents to $101 in Friday's premarket.

One institutional investor, who spoke on condition of anonymity, said that his firm had been allocated 74.2% of the number of shares in its winning bids. Another investor, also on condition of anonymity, said he'd received 371 Google shares after bidding for 500 -- again, a 74.2% allocation rate.

That allocation appeared to be higher for smaller investors, perhaps because of rounding issues. This reporter, whose bid for five shares was accepted (see disclosure below), was allocated four shares, or 80%.

The 74.2% allocation suggests that the search engine company, which along with early shareholders sold 19.6 million shares in its initial public offering of stock, received enough bids priced at $85 or above to sell as many as 26.4 million shares.

That excess demand helps explain why Google's shares rose Thursday: For every 742 shares that the company and insiders sold in the IPO, there was pre-existing demand for an additional 258.

The allocation also indicates that Google could have priced its deal higher than the $85 per share price it set in the IPO. A higher price, which would have eliminated bids placed at the low end of the range of successful bids in the IPO, would have left fewer winning bids, and a higher allocation rate for successful bidders.

A Google spokeswoman declined to comment Thursday.

The allocation illustrates the wiggle room that Google and its underwriters have had in the Dutch auction format that the company employed in its IPO.

In theory, after collecting bids from different investors -- each for a specific number of shares -- Google could have set a stock price high enough so that only 19.6 million bids would have been accepted, enabling winning bidders to receive 100% of the shares for which they had bid. That highest possible price is known as the "clearing price."

But Google, after having received a healthy amount of criticism over the way it conducted its IPO, evidently decided not to squeeze every last dollar out of Wall Street that it might have been able to.

In fact, the company discussed this possibility in its IPO prospectus. "We and our underwriters have discretion to set the initial public offering price below the auction clearing price," Google said, perhaps in an effort "to potentially reduce the downward price volatility in the trading price of our shares in the period shortly following our offering relative to what would be experienced if the initial public offering price were set at the auction clearing price."

However, the company added, "We cannot assure you that setting the initial public offering price below the auction clearing price would achieve this result."

Of course, the pent-up demand for Google's stock -- even if it was big enough for a 20% pop on its first day of trading -- fell short of the demand for some Internet stocks that went public during the turn-of-the-century dot-com boom. The notorious

theglobe.com

, for example, went public at $9 a share in November 1998, rose as high as $97 in its first day of trading and closed at $63.50. It has since been delisted after plunging into the pennies.

While investors who were lucky enough -- or well-connected enough -- to be allocated shares in theglobe.com and other dot-com stocks could make huge profits on the first day of trading, the companies themselves missed out on these huge gains. One of the reasons that companies such as Google choose a Dutch auction securities auction is to keep more of that out-of-the-gate pop for themselves.

However, a Notre Dame professor who has been studying IPOs for more than a decade cautions that without further details on bids from Google, one can't be sure that the market clearing price is significantly higher than the offering price. "You often get a cluster at the market-clearing price," says Ann Sherman, assistant professor of finance at the Mendoza College of Business.

It's likely that there was a cluster of bids around the $85-a-share price, says Sherman, because $85 was at the low end of Google's revised estimated price range for the auction. "If

investors wanted to put in a low bid," she says, "they easily could have put in 85, to see if they could pick up a bargain."

Even so, some people weren't so easily placated. In setting the offering price below its clearing price, Google ended up not with an auction of shares but with "about as traditional an IPO as you can get," said one winning bidder, who said his firm ended up with a 74% allocation. "It was an auction in name only."

At the time of publication, Mannes had no positions in stocks mentioned other than Google, which he was long for the purpose of reporting on the auction process.

TheStreet.com

has waived the provision of its Investment Policy with respect to Mannes' ownership of the stock solely for the purpose of writing stories on Google's IPO. Mannes has agreed to sell his shares as soon as possible following his brokerage firm's 30-day "no-flipping" window for initial public offerings. As the situation warrants, he will be reimbursed by

TheStreet.com

for any losses, or donate any gains to a charity to be named later.