Back in August, as Google's Dutch-auction IPO drew near, advisors across the country were dropping red flags all over clients who asked about jumping into the bidding, warning them away from the stock and the unusual process.
No way, they said; despite the Google hype, this IPO did not fit into their idea of what sensible, long-term financial planning means.
Now, even as Google stock has climbed beyond even the top of its original offering price range of $108 to $135 per share which was dropped to $85 before the auction many still believe that getting Googled at this early point is not a wise investment.
Advisors also don't believe that the Google experience is going to lead to an explosion of the auction process for IPOs. They likewise do not see the rocketing price of the stock as a harbinger of good news for the tech sector.
What is it about Google that has so many advisors gagging while investors are going gaga? One major problem is that they don't see a business plan bringing in revenues sufficient to justify its sky-high market capitalization-$37.2 billion as of October 13.
"I don't like stock like that, with a valuation like that, and it keeps growing," says Stephen C. Craffen of Baron Financial Group in Fair Lawn, N.J. "The only people who are going to make money off a stock like that are the insiders at the company. I think the true valuation of Google is maybe one/hundredth of what they are in the market."
Google, Craffen says, "will have to increase earnings by like a factor of 14 over the next ten years to justify that valuation. I don't know many companies that can sustain that over a period of years. I just don't see it."
Baron has a conservative approach to investment ("We like value stocks-we think value is where to go.") so its clients naturally share that bias, which Craffen says made his job a little easier when Google fever was spiking in August. "We had only a few who asked about it, and that makes me happy. But I had to bat them down."
Sebold Capital Management in Chicago has a less narrow view of picking stocks, but Sean Sebold had the same response when clients started talking about Google. "We had many people asking about it, and we counseled them all not to, based on the valuation, based on why people were investing in it," Sebold says. "This was the most hyped stock since the Internet days. That doesn't always make it an investment that makes sense. We want to make money, but we take risk into account. Given the lack of historical valuation, given the rate of growth that will have to happen, I thought there were better opportunities. In hindsight, it has done very well. But looking at it today, I still wouldn't buy it. Now it's trading at around 200 times earnings, and that's still a bit pricey for us. There are better investments out there, given their risk profile."
Craffen also cites the ghost of the tech boom and bust. "Google is what we'd call a sexy stock," he says. "People love the concept. This is almost like tapping history, going back into the Internet craze. It's boundless. The hype tends to overrun the real value there. We actually saw it in the past." Eventually, he says, "The realities of the business world tend to bring these companies back to earth. It's very hard to have the earnings growth to justify the valuations that these companies get. A lot of people are going to get hurt by it."
Some problems that cropped up during the build-up to the auction also left advisors skeptical. The company was forced to acknowledge that it might have violated securities laws by not properly registering shares and options it awarded to employees in the past. During the silent period just before the IPO period, Playboy published an interview the company's founders had given in the spring, which the SEC is reviewing to see if they gave out information not included in the prospectus.
"I was surprised by the technical mistakes they made," says Morris Armstrong of Armstrong Financial Strategies in New Milford. Conn. "I don't know who was advising them, but you just never hear of so many gaffes in an IPO. ... Now you have the possibility for future litigation, and you just don't want that."
Armstrong says Google left him completely uninterested, and the feeling extended to his clients as well. "I only had two clients who were interested. I suggested that they could wait, and get in later if they were interested. Neither of them participated in the IPO."
Dave Moran, senior vice president at Evensky, Brown & Katz, Coral Gables, Fla., says he found Google's penchant for secrecy to be alarming. "This was apparent when reading the first red herring of the disclosure statement, where they basically said, "When you need information we'll give it to you, so don't ask,'" Moran says.
Moran adds that he finds Google's three-person senior management team-"the triumvirate," as he calls it-to be troublesome. The offering included two shares of voting stock, allowing the founders to keep a considerable amount of voting control, and thereby diluting the power of other shareholders. "You have this three-person structure and a lack of a succession plan, and a seeming lack of desire to talk about a succession, and this goes against what we are as planners," Moran says.
Armstrong, too, questions the Google corporate framework. "One of the reasons I was cautious was the structure of the company. There are a lot of unknowns in it." What the company's course for future growth will be, and the likelihood of increasing competition, also factor into advisors' appraisals of Google.
"It's a company that has a lot of press, that's got a lot notoriety to it," says Sebold. "But if I look at something that has to grow at a rate of 200% a year, given the revenue model, then I think it's overpriced. Their growth rate is coming down. It's still in the 100% range, but it's coming down, not going up."
Sebold cites "the threat of competition" from the likes of Yahoo and Microsoft as potentially undercutting Google's core business, even as the company looks to broaden its revenue stream. "That's the wonderful, and awful, part of doing business on the Internet-it's open. You can't hide from the competition. ... Your competition can check you out every single minute of every day. That is chance for the competition to come in. They don't have the brand Yahoo has, don't have the content yahoo has, don't have the 'stickiness 'of a Yahoo."
Stickiness means "people go back to it frequently," Sebold says. "My wife has a bulletin board on Yahoo with her mothers' group. She's always going back to it. Amazon is trying to develop the same sort of thing. But a search engine is a search engine is a search engine, at this point."
The Google offering was made as what had been viewed as a revival in the tech sector- which many investors had hoped Google would energize- sputtered out over the summer, based at least in part to concerns in the market about high valuations for Internet companies. While advisors don't believe Google will provide the spark to ignite sustained growth in the sector, they are generally optimistic about tech stocks in general.
"I see tech getting better," says Armstrong. "It depends on the pricing ability. You're still waiting for the sector demand. Corporations must be getting ready to go out and replace their IT infrastructure. It's been four years. But I don't think you're ever gong to see the multiples you saw before 2000. That's gone."
It's not clear, however, that a recovery in the technology sector will rekindle a boom in tech stocks. "I think we're getting to a point in general where people will be buying new technologies," says Sebold. He cautions, however, that a cascade of new products coming into the market too quickly will leave would-be purchasers sitting back and waiting for prices to settle out .
"I equate that to deflation," Sebold says. "Nobody buys anything because everyone's waiting for the price to come down
Craffen, however, says the issue of high valuations keeps him skeptical of the entire tech sector. "The average P/E for a tech company is around 35. We look to find companies with a P/E around 15," he says. "We tend to look at it on a company-by-company basis, at individual companies. We're not worried as much about the sector as we are about paying a good price for the stock. People tend to lose sight of that. They're buying a concept, not a company. But you are buying a company. A concept can evaporate in a minute-earnings are what are real, and that's what you have to look for."
The valuations of many Internet companies "are just fluff," Craffen says. "They're based on anticipated future earnings that may not ever occur; they can just disappear overnight. A company that is more valued by current earnings and less than by its future earnings won't have that kind of volatility."
One thing that the advisors agree on is that none of them consider Google to be a tech company at all. "Is someone who does electronic billboards a tech company?" asks Sebold.
"When I think of technology, I think of chips, of the networking industry. I don't tend to think of a marketing firm as a technology company," says Armstrong. "You put it in the technology sector, it's online, but it's really a marketing company. I don't think Google is really a technology company."
"Myself, as an advisor, if you strip away everything, it's really the brand name being sold," says Moran. "Google is a brand name, which is what they sold."
As for the Dutch auction process, the advisors don't expect a sudden rush of copycat offerings. They note that such auctions have been used in the past, albeit not for such a high-profile IPO. Despite the flubs and the flaws in Google's effort, they seem to find the exercise rather charming.
"It's nice that they used a novel approach, but it's not unique," Armstrong says. He does see positives in the auction, however. "I'm sure it was much less expense to Google to run an auction than a traditional IPO," he says. "I think people will look at it as a realistic alternative, but the company going public has to have a lot of hype going for it."
"An Internet company using Internet technology this way is appropriate," says Moran, who adds that it's an improvement after the recent Wall Street scandals revolving around traditional IPOs. One problem, he says, is that as in any auction, the buyer might not behave logically. " The fact you want to win becomes the driving force."
Sebold agrees, noting that the buyer is completely on his own in assessing the offering. "You better have done your homework; the auction process is not going to do it with you."
However, says Sebold, "I think it's a good process in general, from a capitalistic perspective. But we saw some of the warts. ... It lowers the cost of equity to the company. I think it makes a whole lot of sense. But I think it still has to be priced in a manner that the people taking the risk get compensated for it. In this case, when you have the less-educated retail buyers making the decision, they don't know how to research that. There's a lack of knowledge there that could cause people to make decisions that are inappropriate for them."
Even with the negative view of the company's huge market capitalization and the IPO process, some advisors aren't necessarily completely negative about Google. "I think it's probably a very good company," says Craffen, "but it's not a very good stock."