Google's IPO: Financial Strategy and Dual-Class Stock Structure

Introduction: Google's IPO Overview

Google's initial public offering, commonly called an "IPO," is undoubtedly one of the hottest topics of its time. Like many initial offerings from well-known and successful companies, many investors harbor great optimism regarding the company's potential during the IPO phase. However, like most initial offerings, Google's endeavor is full of several complex, unusual, and uncertain factors. Regardless, one must begin with the facts.

Financial Management Strategies and Breaking with Convention

Google's IPO took place on August 19, 2004, at an opening price of $85, significantly lower than the previously projected low price of $108. Notably, Google chose to use an innovative method of offering shares to the public via "modified Dutch Auction," in which 19,605,052 shares were offered at a value of $1.67 billion, with an initial market cap of $23.1 billion (About, 2004).

Google's brand loyalty among internet users is legendary. Many remember the early days of dial-up internet services and their limited search engines, only to be unexpectedly presented with a far superior option. Google became the rallying cry for web surfers everywhere, and the site continues to enjoy strong user allegiance that is difficult to match. Whether this well-deserved loyalty would extend to Google's recent IPO remained uncertain. After all, few investors who survived the collapse of the technology and startup boom are as trusting as they once were, even concerning immensely popular and iconic companies.

Cash Flow Valuation and Market Comparison

Perhaps in response to this reality, Google broke with convention in a bid to garner optimistic buying among the public. By offering a relatively unheard-of Dutch auction, the company sought both to rein in any initial extreme overinflation of the stock—much like that found in VA Linux (La Monica, 2004)—and to draw interest through the method's novelty. One can appreciate the forethought in Google management's important moves toward preventing a "helium-infused opening pop" (La Monica). However, according to some analysts, this attempt may still not be enough to ensure reasonable pricing. The reason for this concerns the wide discrepancy between the lowest expected price range of $108 and the actual cash flow realities of the company.

Valuation of Google cannot be considered without comparing it to that of its rival Yahoo. Indeed, this comparison provides significant insight into the possible problems that may eventually emerge in an overvalued stock. The low price of $108 represented a full 19 times the projected cash flow for 2005. Many analysts instead asserted that Google and its investors should consider Yahoo as a benchmark for early pricing, with Google stock trading at least 25 percent below Yahoo's valuation. This, according to analysts such as Mark Mahaney of American Technology Research, would accurately reflect the value of a company significantly less diversified than Yahoo.

Why Google Went Public: Objectives and Benefits

So why did Google set its opening price so high? The interesting answer lies in its very unorthodox offering via auction, which may have played a significant role. Unlike the more "traditional" IPO system, in which bankers set prices low to ensure sufficient profits, the auction system allowed the company to set a higher price while reaping the reward. The actual individual stock buyers also benefited. However, although many consider Google's management of the IPO offering via auction to have been a stroke of genius, many also consider its initial July price projection to have been foolishly high—so high, in fact, that some commentators labeled it nothing more than stark "hubris" (Gillmor, 2004).

Many consider the question of "why go public" to be an obvious one for most companies. Although Google had been extremely successful financially, the main goal of going public was to allow its principal investors to gain some control of their funds in a "liquid form" (PBS, 2004). Additionally, in an atmosphere of increasing competition and sophistication of similar products, including Yahoo, it was essential for Google to capitalize on its remaining "on top" loyalty while still positioned to do so. This not only assured a high valuation of the stock by buyers but also allowed for the greatest amount of profit to be realized from its popularity. Of course, this meant that the company could be in an even greater position to withstand growing competition. More funds simply equaled greater development capability, helping Google to "keep ahead of the game."

Another interesting aspect of Google's IPO concerned the positive position that company management and founders gained from the auction method, specifically in creating two different "types" of stock (PBS). Google's IPO offerings were made up of two classes of stock: those offered to the managing founders, which carried voting weight worth ten times that of ordinary shares, otherwise known as "super stock," and those offered to the general public. In doing this, Google was able not only to maximize its share of the profit in the offering as opposed to the investment banks, but by using this "two-tiered" stock system, the company still managed to maintain significant independent control over operations—something other "search"-heavy companies only dream about.

Dual-Class Stock Structure: Innovation or Mistake?

In fact, the company seems positioned to remain highly self-controlled. As Charlene Li characterized in her PBS News Hour interview, the company's message to shareholders is clear: "You're investing in a company and an executive team that really knows what's going on, and either you buy into us and our strategy or you don't. And sure, we'll be listening. We'll be listening to our advisors and listening to what the market says but we won't be beholden to quarterly earnings, quarterly expectations because frankly we need the flexibility and the speed in the marketplace to be sure to do the right thing."

Within the computer and internet industry, having flexibility and the funds to support that flexibility is one of the essential components of competitive innovation. However, there is significant criticism of Google's management regarding their decision to offer two different types of stock.

Conclusion: Revolutionary Approach and Future Outlook

Although there can be little doubt that innovative and creative thinking can flow more freely when one is not constrained by the voting whims of the "masses," many believe that Google management's creation of the "super stock" versus "normal stock" is a mistake. Indeed, although Google would by no means be the only large company to adopt the dual-stock model, there seems to be a trend among companies with "entrenched management" to "under perform rivals that are accountable to shareholders and vulnerable to hostile takeovers" (Valdmanus).

In fact, in a recent study conducted by Harvard and Wharton, researchers Paul Gompers, Joy Ishii, and Andrew Metrick found that "buying companies with the best corporate governance and selling the firms with the worst would have yielded excess returns of 8.5 percent a year during the 1990s." Further, they also found that "dual-class firms tend to invest too little, leading to lower sales growth and valuations" (Valdmanus). These findings suggest potential long-term challenges with Google's structural approach, despite its immediate benefits for founder autonomy.

Although Google's method of conducting its initial public offering was revolutionary in the extreme—perhaps reflective of its rather unique founders—there are significant criticisms as well as optimism regarding its overall nature. Key among these issues are the overvaluation of the initial projected offering before the actual IPO date and the extremely controversial "dual types" of stock. However, the fact that the method by which Google's founding management sought to offer its company to the public brought significant gains to the company is difficult to deny. Chief among these gains is the ability of Google to maintain significant control over its operations while still enjoying the liquidity it needs to continue innovating and surviving in today's internet landscape. Whether the fate of the company will be less than rosy is yet to be determined. What is clear, however, is that in its IPO, Google managed to stay true to its revolutionary nature. Whether that nature allows the company to stay ahead in the competitive game will be the real test of time.