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MENDOZA IN THE NEWS

Taking stock

Loving Google and buying it are two different things

by Erin Schulte, Wall Street Journal
Publication: Dow Jones & Company, Inc.

August 6, 2004

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Everyone adores Google.

Practically indispensable for anyone who spends eight hours a day deskbound and the main crutch of every writer I know, Google consistently garners the biggest share of U.S. Internet searches, comfortably beating Yahoo, MSN and AOL.

But you shouldn't twist Peter Lynch's old "buy what you know" rule to suit your purposes. Because even if you know -- and love -- Google, its shares could be in for a bumpy ride. Investing professionals are advising individual investors to stay away from the offering, cautioning that once it starts trading Google's stock is unlikely to enjoy the enormous gains seen in traditional IPOs in the late '90s.

Those determined to get in on Google should, at the very least, be patient -- and prudent.

"Don't put all your money into it -- this is speculation money, the money you can live without," says Tom Taulli, co-founder of CurrentOfferings.com and co-manager of the private equity fund, Oceanus Value Fund. "Wait for a few earnings reports, and at some point, the market will price in the lockups and discount that. Looking at the technicals, you may get a better price by waiting three months."

Google itself warned its prospectus that there may not be the big price pop IPO investors have come to expect because of the way the auction is structured. The variation on the Dutch auction system will require investors to place bids, and the company will then set its clearing price at the highest level that allows it to sell all its shares.

To simplify: the final offering price on the stock will be the price bid by the investor for the last remaining share. Even investors who bid above that price will get the lower price. Because of that, investors often bid high to ensure they will get shares, and when trading begins, prices can drop.

"What's tricky is that what you want to do depends on what everyone else is going to do. A lot of articles say this won't be a good deal, and if there are enough like that, then suddenly you would want to be in on this," says Ann Sherman, assistant professor of finance at Notre Dame. "But if everyone's excited, you want to stay as far away as you possibly can."

Big institutions have reservations about the IPO, and less-experienced individual investors -- unless they feel like taking a gamble -- have little to gain from jumping on it either. One of the biggest criticisms has been that the price range -- estimated at $108 to $135 by the company -- is too high.

"Why go through all the brain damage of this whole process when you're not getting rewarded for it? Wait until it goes into the marketplace, and then you don't have to rip your hair out trying to figure out what kind of bid to put in," says Mr. Taulli. "You're not getting any type of advantage by going through the auction."

Of course, professional investors are best off talking down the stock so lower bids will still garner shares. But still, common sense suggests Google could falter once it starts trading.

Chatter on message boards last week revealed small investors' disappointment with the triple-digit price, especially considering that tech stocks are down so much in recent weeks. The Nasdaq Composite Index has fallen 3.4% since Google announced its price range on July 26.

"They associate themselves with Warren Buffett -- they want investors in it for the long term and don't want to split shares," says Mr. Taulli. "It's a gimmick, and a big mistake -- retail investors see this as being overvalued."

Even though their valuations will be similar after adjusting for the number of shares available, many are asking why they should buy Google shares when Yahoo, which has a more diverse revenue stream, is trading at a far more attractive price. (Yahoo shares closed at $26.02 Friday)

That's a psychological barrier: Google stands to be the biggest IPO on a price-per-share basis, surpassing Genentech, which went public for $97 a share in 1999. Mark Mahaney, an analyst at American Technology Research in San Francisco, estimates fair value for Google is around $108, based on its earnings guidance. That doesn't mean it's the price shares will actually go for, but it's what he feels they're worth.

High prices don't always scare off investors, of course. Genentech saw its shares shoot up about 149% in the six months after it started trading. But it was a traditional IPO, structured to show a price gain in early trading and make everyone -- investors, investment bankers and insiders -- happy with the outcome.

Even if the price doesn't falter when it begins trading, the stock could be more volatile than competitors. The founders of the company say they won't be giving detailed earnings guidance -- though they may reveal long-term trends they see in their business -- because "a management team distracted by a series of short term targets is as pointless as a dieter stepping on a scale every half hour."

That's all well and good for Google, but could create indigestion for shareholders. Wall Street analysts will be forced to set targets blindly. If Google can't pin the tail on the donkey, and quarterly results come in well ahead or below of those, the stock could be in for stomach-lurching swings.

"The other companies in the space give very detailed guidance," says Mr. Mahaney. "EBay, for example, does guidance for every quarter of the upcoming year and has a very good record of meeting or beating it.

"The company has a lot of visibility and so do investors -- there are fewer surprises and people are willing to pay for that," he says.

Another potential problem for Google is a number of staggered "lockup" dates that start soon after the IPO. Google employees and those who buy the stock early on will be able to start selling the stock as soon as 15 days after the IPO. Investors could wait until after some of the lockup dates pass to see how intense the selling will be.

For employees sitting on a mountain of stock, the temptation to sell could be acute, even if the price of the stock doesn't escalate much after the IPO.

"It's a catalyst -- and not a positive one," says Mr. Mahaney. More investors will be allowed to sell millions of shares at the three, four, five and six-month anniversaries of the offering.

Even in Silicon Valley, where you might expect interest in the offering to be higher, investors are wary, some financial planners say.

Karen Goodfriend, a financial advisor at Allied Consulting Group in Los Altos, Calif., has many clients who made their fortunes at Silicon Valley tech firms in the late '90s. She says clients are curious about what will happen with Google, but aren't expressing any interest in investing. The problem isn't even necessarily the price, she says, but the speculative nature of the investment.

"People have seen a lot here, and if it were the late '90s, there would have been a higher interest for something like this," Ms. Goodfriend said. "There's much more perspective today, and there's a lot of risk in making a big investment in a company like this -- clients are more interested in having diversified portfolios than speculating."