Lessons from Google IPO

The recently concluded IPO by Google, the Internet's most popular search engine, generated more buzz than usual for several reasons. For one, it was the first major Internet-related offering since the dotcom bust.

Another reason was the ultra cool, rags-to-riches, small-guys-hit-the-jackpot image of its promoters. But the real reason why the issue became something of a cause celebre was the way in which the company decided to make the flotation.

Instead of going down the beaten track of roping in investment bankers to hawk the issue, Google decided on a Dutch auction. This process enables price discovery to be achieved not by investment bankers building a book, but by direct bids from those wanting to buy the shares. This eliminates the intermediation of the investment banker. Naturally, Wall Street was less than pleased with this innovation.

Google wasn't the first to go Dutch, but earlier IPOs that chose this kind of auction method were too small to make much of a splash or threaten entrenched interests on Wall Street. Google changed all that""it was too big to ignore, and it was well-known on Main Street.

The company had enough clout not only to make sure that underwriters flocked to its issue but was also able to cut underwriting commissions drastically. Its founders made plenty of mistakes, such as granting an interview to Playboy, which appeared during the so-called "silent period" before the issue.

The company then failed to account for stock options granted to employees and was forced to offer a buyback. The promoters may also have got carried away by their own hype and set the initial indicative price of the offering too high. Thus, when they were subsequently forced to reduce the price band from $108""135 to $85""95, many concluded that the issue was a bit of a flop.

Not quite. The whole point of an auction is that it enables proper price discovery, and there is nothing wrong in scaling down price expectations in tune with what the market wants.

As for critics who felt that the Dutch auction may leave nothing on the table for investors post-allotment, the jump in Google's price since listing should come as an eye-opener.

In the final analysis, the success of the issue also stems from the fact that Merrill Lynch and other Wall Street firms participated in the auction. So what are the lessons to learn from the Google IPO?

If more companies resort to the auction method, it could put a check on some of the more egregious misuses of the bookbuilding method, such as allotting shares to favoured cronies and allowing them to make a killing. However, the point is not that the Dutch auction method is better than the traditional book-building route.

What is noteworthy is Google's decision to be innovative about a new way to raise money. The world over the markets need to experiment with new approaches so that the best practices finally win out. Sebi would do well to take note of such innovations and encourage companies to experiment with them under controlled conditions.