Google's brand new deal?

Vic Fleischer recently announced the law review placement of his new article on use of deal structure as branding techniques, prominently featuring the Google auction.  Congratulations to Vic on the success of his interesting new paper.

I think Vic’s story is quite plausible: that Google chose the unorthodox auction over bookbuilding, although the auction may have left a lot of money on the table (compare the $85 auction price with where it is now), as part of its effort to build the brand.

Here’s a long quote from the working paper (footnotes omitted):

The Auction IPO enhanced Google’s brand image by solidifying its reputation as being more concerned with integrity than insider profits. Dot com founders became millionaires (or at least paper millionaires) by cashing in on IPOs. Google’s founders are paper billionaires, but their choice of deal structure reflects little desire to cash in quickly at the expense of long-term shareholders. Google presents an image of being democratic and non-elitist. . . . . The prospectus materials suggest that this egalitarian image was important to Google. . . . . The auction pricing mechanism played into this image. Rather than having underwriters set the price using the traditional book-building method, investors set the price for shares over the Internet. The voice of the people, not Wall Street insiders, set the price. Whether the auction resulted in a more accurate price was almost besides the point. The deal structure eliminated the favoritism problems that accompany the traditional process and gathered information in an even-handed manner.

I have some thoughts on this.  My point is not at all to criticize the paper, which I found quite engaging, as indicated by this long post, but to offer another side. 

The main question for me is not whether deal structure can be used as branding, but the cost-effectiveness of the stratagy compared to other approaches.  And I have a subsidiary question about the extent to which branding actually motivates deal structure, including in Google.

I discuss this because it relates to a broader question about corporate social responsibility vs profits. Pro-CSR folks often say that profits mesh with CSR because it all comes out in goodwill. And I argue in my Accountability and Responsibility  article that the two do mesh to some extent. 

Getting back to Google, price accuracy cannot be even “almost” beside the point, as Vic says.  For the brand-building story to work, Google has to have gotten a lot of brand value to make up for the money that seems to have been left on the table.  Although Vic tells a story about how the sort of nerds that use Google would really care about deal structure, and quotes press stories backing up the brand image effect, I wonder how much lasting imprint on the brand the auction could have had, compared to alternative investments in branding.  Moreover, when you eschew the established methods, you increase the risk that something unexpected might happen, causing the whole thing to backfire.  This suggests that building a brand image of innovativeness is inherently risky.

So my suspicion is either that Google made a business mistake, despite the branding explanation, or something else was going on. Well Vic’s co-blogger Christine, in her interesting paper about the Google auction, does get at what she calls a “more cynical explanation” for the deal structure:

With hours left in the bidding process, Page and Brin not only drastically lowered the price range, with the resulting $85 per share being 58% of the highest suggested $135 price, but they also reduced the number of shares that they personally would sell at that price. Instead, they were able to sell shares 180 days later at a much higher price, once they shrank the supply. In a traditional bookbuilding offering, the investment bank can manipulate the price to ensure that certain parties capture part of the demand curve. Here, Google insiders may have manipulated the price to do the same thing. Most participants agree that there were not enough bids on August 18 to allocate all the shares at $135. However, the end result of the Google auction was that bidders received 75% of their bids, strongly suggesting that the shares were oversubscribed at $85 and that the clearing price was more than $85.135 These facts seem consistent with the argument that the shares were underpriced intentionally. In fact, Page and Brin have been able to time the sale of their stock to coincide with share price increases. Although they could not possibly have predicted that the share price would increase to almost $300 in June 2005, the founders were able to sell shares worth over $100 million each at that time, about 3 ½ times the value they would have received if they had sold the same shares in the August IPO.

So much for equality, unless it's an Orwellian sort of equality. But wait, it gets worse.  Today’s W$J, under the ironic headline “feeling lucky,”  undercuts not only the equality of the offering, but also its transparency:

Shortly before the August 2004 initial public offering, when demand proved less than anticipated, Google slashed the expected offering price range. Some insiders who had large stakes in the business and seats on its board decided to cut the number of shares they planned to sell -- in some cases not to sell any at all. Now, with Google stock up 256% since the offering, the value of the shares they held onto is up about $1.7 billion. Some early Google investors didn't get this same opportunity to reduce their share sales.

The insiders who got to cut and hold included, you guessed it, Page, Brin and Schmidt, who sold about half what they initially planned, holding onto a total of more than 1.3 million shares.   

The above facts cast more doubt on branding as a motive, or at least exclusive motive. Moreover, it seems that, whatever the branding motive, it may have backfired. Branding is an investment in reputational capital.  When you do something inconsistent with the image you’re trying to build, you in effect pay a “fine” in the amount of the reduction of your investment in the brand.  That may happen here.  Just as the brand-creation effect of the auction is waning, we get a prominent story that cuts precisely the opposite way.

What’s the overall lesson?  Reputation-building is a powerful force in business. But it is also easy to load too much into that explanation.  Cynicism is always healthy.

Comments

[Ann]

Hindsight is convenient, isn't it? Looking back now at those that cut their shares in the auction, it's easy to imply that they knew the price would be higher later. I was surprised at how the second half of the WSJ article almost contradicted the first – the article was written to sound scandalous while de-emphasizing (but still giving) plausible explanations for everything. Google had to quickly decide what to do at a chaotic time in which they were concerned that the auction would fail (as so many IPO auctions have). Ex post, those that cut back their share in the IPO look privileged, but shouldn't we judge them based on what they knew at the time?

As for the rationing rate indicating that Google deliberately underpriced the IPO, we can't be sure either way, since the US is more secretive than most countries regarding IPO results. However, since pricing below market clearing has been quite common for IPO auctions (the UK and France especially have done quite a few "dirty Dutch" auctions, while in the US there was Overstock and Andover.net), it wouldn't be surprising.

What assumptions are behind your claim that a lot of money was "left on the table"? Are you assuming that the later market price was inevitable? Are you assuming that an offering can be priced at that inevitable aftermarket price with zero risk? Are you assuming that investors will devote a lot of time and effort to helping the investment bank set the price in exchange for lots of risk and a zero average return? Why should others come to the table if the issuer plans to leave nothing for them?

I think branding played a role in Google’s choice, although I think they also genuinely believed in a “true demand curve” that they could tap into through an auction. Whether they’re still true believers in equity auctions might be evidenced by their decision to not use an auction for their recent follow-on. That would have been an even bigger branding event – after all, there have been hundreds of IPO auctions over the last few decades, but there have been very few auctions for seasoned equity offerings (I know of only one, for Overstock, although the Australian government reportedly considered one for Telstra’s second follow-on). Why didn’t Google use an auction the second time?