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Wednesday, May 05, 2004

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Google's public offer

By Floyd Norris

Google wants to change the system and in the process pay investment bankers less.

AS THE symbol of one era of initial public offerings faces the possibility of prison, a new era that rejects the excesses of the past may be starting.

For a few years at the height of the technology boom, Frank P. Quattrone was the most powerful investment banker in Silicon Valley. It was not just that his decision to bring a company public could make its founders wealthy beyond ordinary people's imaginations. He had the power to hand out wealth to others just by allowing them to buy the stock he was selling.

"When someone gets control of the capital-raising process, it's very lucrative," said Andy Kessler, a hedge fund investor who once worked with Quattrone. "But his downfall was that at the other end people lost money."

On Monday, Mr. Quattrone was convicted of obstruction of justice for passing on an e-mail message urging investment bankers who worked for him at Credit Suisse First Boston to clean out their files. The warning message came after he learned that regulators were looking into the IPO process at the firm.

Once, Wall Street considered it embarrassing to have a stock soar right after it went public, because the underwriters had obviously left a lot of money on the table and deprived the issuing company of the best price for the shares sold.

But in the late 1990s it became a badge of honour to have a new offering double or even quadruple the first day of trading. That meant the potential for phenomenal profits to those who could buy at the offering — profits that could be realised within minutes after the stock began trading, long before it became clear whether the company would prosper.

Mr. Quattrone put himself at the centre of that process. Moreover, despite nominal rules separating investment banking from research, Mr. Quattrone had analysts reporting to him, allowing him to influence their recommendations to clients.

Few were exercised about the matter until the bubble burst. Investigations began, and there was revulsion at the way the guaranteed profits of buying hot offerings were split up.

First Boston paid a $100 million penalty, but no criminal charges were brought against the firm. Mr. Quattrone, however, was indicted because prosecutors thought he had tried to cover up what had happened.

Now the market has regained a good part of its losses. Many technology stocks have doubled or tripled — admittedly from low bases — in the last 18 months. And investors are bracing for Google, the most highly anticipated new offering in years.

Some reforms have been introduced, including barring research analysts from communicating with bankers on public offerings.

But imposing such institutional changes from outside can go only so far. Google, proprietor of a successful Internet search engine, wants to play by different rules. It proposes to sell its shares in a version of a Dutch auction. That means any investor — whether the best friend of the lead underwriter or a small investor in Fargo, N.D. — should have an equal chance of buying shares at the offering price. The auction will set the price.

Whether either of those investors will do well is another issue. In the old days, investors in offerings known to be hot could be sure of making money, and so they pushed to get in on the offering regardless of how much they thought the shares might be worth or how likely the company was to prosper in the long term. They might flip the shares immediately for a quick profit.

Regulators are considering trying to protect individual investors by requiring that orders to buy such stocks the first day must specify a maximum price the investor will pay, rather than simply being for a market price that could have soared.

But the Google plan makes such steps unnecessary, because first-day profits are far less likely to exist. By the nature of a Dutch offering, investors will know that they probably can buy in the aftermarket at a price comparable to the offering price — just as investors who buy any stock now trading, whether General Motors or Yahoo, know that the market price tomorrow is likely to be pretty close to today's price.

There is no certainty that Dutch auctions will do an especially good job of raising capital. It may turn out that underwriters, in weighing markets and seeking to price offerings so that they will sell and rise maybe 15 per cent in the aftermarket, did a good job for their customers all these years. The risk in the auction process is of setting a price that will appear too high within days.

But Mr. Quattrone and other investment bankers stopped doing an important part of their job in the late 1990s, even though few objected at the time. The bankers were quite happy to spread profits around to people they favoured or people who could do favours for them. They left a lot of money on the table that could have gone to the companies that hired them.

Now Google wants to change the system, and in the process pay investment bankers less for their services. That approach, as much as the conviction of Mr. Quattrone, reflects the reaction to the excesses of the era that enabled Mr. Quattrone to be paid more than $200 million from 1998 through 2001. —

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