Keeping Google IPO mania in check

Finance expert Tom Taulli explains that when Google finally does hit the public markets, it will be the first real test of a high-profile tech IPO in the new--and far more sober--regulatory environment.

Tech is a bizarre type of business. True, it is fueled by incredible innovation. But there is also a need for a good amount of hype and, yes, greed.

If anything, what really sparks tech is a red-hot initial public offering. Looking back in history, some of the defining moments included the IPO of Apple Computer, the IPO of Microsoft and the IPO of Netscape.

Why the power of the IPO? It may be more psychological than anything. It is an indication that investors are willing to take risks. It also helps with the tech value chain. That is, angel investors and venture capitalists loosen the purse strings--since there is an exit strategy in the foreseeable future.

No doubt, since the bust of 2000, the IPO market has been in a death spiral. Until recently, the IPO market was in its worst dry-spell since disco became big during the 1970s. But the drought may be over. And the spark is likely to come from Google.

Timing is everything--and it may be perfect for Google. The equity markets have hit year highs; investors are getting tired of earning less than 1 percent on their money market accounts; and many dot-com stocks have seen their stock prices soar, such as Amazon.com, Yahoo and eBay. Despite being a young company, Google is in the same league as the dot-coms just mentioned. Some analysts believe that Google generated revenue of $300 million last year and is on par to see revenue surge to $700 million this year. Moreover, this is apparently high-margin revenue.

This growth ramp will certainly excite many institutional and retail investors. Actually, it would not be surprising to see a moon-shoot opening day for a Google IPO.

The big problem with the Google scenario is the heap of new regulations on IPOs and public companies. In a recent Forbes story, Google CEO Eric Schmidt was reported to be in meetings with managers that were called by the code-name "Keeping Eric Out of Jail."

If you are a tech executive and have friends at Google or at its underwriters, do not expect any complimentary allocations of IPO shares. That nice little game--known as "spinning"--is over.
For executives of public companies, no doubt the big thing is avoiding the slammer. According to the new Sarbanes-Oxley Act, the CEO and CFO must certify their financials. If the financials prove to be fraudulent, there are hefty fines and even prison sentences.

Assuming Google hits the public markets, it will be the first real test of a high-profile IPO in the new sober regulatory environment. What will this mean? Well, if you are a tech executive and have friends at Google or at its underwriters, do not expect any complimentary allocations of IPO shares. That nice little game--known as "spinning"--is over.

Next, analysts cannot be cheerleaders for an IPO. Ironically enough, analysts will now have to engage in real analysis--and not be compensated for investment banking work. A "buy" recommendation must now be based on something more substantive than a knee-jerk Pavlovian reflex.

In light of a recent report from the New York Stock Exchange and the National Association of Securities Dealers, the Google IPO may need to take some interesting steps in the pricing of the offering. Traditionally, the ultimate price of an IPO is based on a tug-of-war between the company and the underwriter. With the new proposed rules, there will be an independent pricing committee of directors, who will have access to all the indications of interest for the IPO. This should help avoid the severe underpricing of IPOs. This means companies should be able to raise more money in their offerings.

Ironically enough, analysts will now have to engage in real analysis--and not be compensated for investment banking work.
Other reforms include: not allowing market orders on the first day of trading; complete transparency of who gets shares in the IPO; no more "laddering" (a process by which investors are required to buy more shares as the stock price increases); and the repeal of antiflipping rules (flipping means immediately selling IPO shares when allocated, so as to make a quick profit).

Finally, there is a proposal to make it easier for retail investors to get allocations of IPOs.

So, let's see: With the new regulations, executives go to jail if they juice the books; there are rules against analysts pumping stock; there are rules against spinning IPOs to favored executives; there will be less price manipulation (no more laddering); companies will get more money; and there is more access to individual investors.

Sounds good to me.

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