Google takes a gamble

Google plans to become a public company have been rumoured for months and the expectations for its IPO are extremely high in the technology sector.

The proposed maximum aggregate offering price $2.72bn.

Morgan Stanley and Credit Suisse First Boston are the underwriters and they will be in charge of conducting an auction process on Google's behalf to determine the IPO price, a method Google acknowledges is unconventional in the US. The auction will consist of five stages - qualification; bidding; auction closing; pricing; and allocation.

"It is important to us to have a fair process for our IPO that is inclusive of both small and large investors. It is also crucial that we achieve a good outcome for Google and its shareholders. This has led us to pursue an auction-based IPO for our entire offering," the filing reads.

"Our goal is to have a share price that reflects a fair market valuation of Google and that moves rationally based on changes in our business and the stock market."

The company will have both Class A and Class B common stock, or a dual-class voting structure, which is designed to give the company's management more control over the company after it goes public.  "We have a dual-class structure that is biased toward stability and independence," the filing reads.

The Class B common stock will have 10 votes per share and the Class A common stock, which is the stock that will be sold in this offering, will have one vote per share. This will limit Class A stockholders' ability to "influence corporate matters".

Google's executive team had, so far, resisted taking the company public. Founded in 1998, Google is, reportedly, profitable and the most widely used search engine, but competition is heating up, as Microsoft and Yahoo invest heavily in improving their own search technologies.

"From what we can tell, Google is running a healthy profit now, so they don't  need the IPO cash to survive," said analyst David Schatsky from Jupiter Research, on Wednesday, before Google filed for the IPO.

Indeed, in its filing Google revealed that it closed 2003 with net income of $105.6m and revenue of $961.9m. The company has been profitable since 2001, when it had $6.9m in net income and $86.4m in revenue.

In its filing, Google said it will use the IPO net proceeds for general corporate purposes, such as sales and marketing expenses, research and development expenses and general and administrative expenses; capital expenditures; and possible acquisitions of businesses, technologies or other assets, although it at present has no agreement or commitments with respect to any material acquisitions.

However, two main drivers may be at work in prompting Google to go public. First, the company may be facing mounting pressure to reward investors and employees who have stock options; and second, executives probably understand that they are in an increasingly competitive environment and need more money to develop new services to make Google more attractive to users.

One way of doing that is through services such as the recently announced - and controversial - Google web-based e-mail service, called Gmail, and through features that let users personalise their Google search experience.

An e-mail service links users more tightly with Google and gives them a reason to visit the site regularly, while personalisation ties users with the Google search features.

It is very likely that Google already has in the works a host of applications to go head to head against Yahoo and Microsoft, and could use the IPO cash influx to boost their development, said Patrick Mahoney, a Yankee Group analyst, before the Google IPO registration.

"I can see Google preparing an instant messaging service for example," he said. He also expected to see content-related services and a continued push into the local-search market, which lets users tailor searches based on geographical parameters, and consequently opens up more advertising possibilities.

Google might also use the IPO cash to go shopping for companies that have or are developing this type of complementary technology and services, Mahoney said. However, he did not expect Google to be indiscriminate and overly aggressive in this area. "There's the potential for acquisitions, yes, but Google is very proud of its proprietary technology so any acquisition they make will require a good amount of integration into their technology."

The Internet search market has become increasingly lucrative in recent years as search engines sell advertising matching individual searches. For example, a seller of sporting equipment may pay Google to post its ad when a user enters search keywords such as "basketball", "baseball bat" or "tennis".

Advertising tied to keyword searching was the fastest growing and the biggest of all US internet advertising categories in 2003, according to a report published in April by the Interactive Advertising Bureau and conducted by independently by PricewaterhouseCoopers.

Keyword search revenue made up 15% of online ad revenue in 2002, and jumped to 35% in 2003. The rest of the 2003 US internet advertising pie was made up of display advertising (ad banners) with 21% (down from 29% in 2002), classifieds with 17% (up from 15% in 2002) and rich media advertising with 8% (up from 5% in 2002), according to the report. Internet advertising for all of 2003 reached just under $7.3bn, up nearly 21% from 2002.

To sustain and grow an advertising-driven business, an internet company has to attract and retain visitors. "In the most basic sense, one of the most important components of a successful advertising medium is a loyal and active user base, and applications such as e-mail help increase that loyalty, because of the stickiness effect," said Graham Mudd, an analyst with market researcher comScore Networks, before Google filed its IPO registration.

"Google's introduction of Gmail in a lot of ways signals an intention to move into lines of business generally associated with web portals. I wouldn't be surprised if the new capital were used to develop efforts similar to Gmail," Mudd added.

Gmail is in early testing phase and only available to a very small set of users, but it has already generated a strident controversy, as privacy advocates have rushed to condemn Google's plan to include ads in the body of e-mail messages based on an analysis of the messages text.

Google would detect, for example, that a message mentions the word "boat" many times, and thus include an ad from a maker of marine equipment. Critics say this amounts to Google snooping on users' e-mail messages. Google says the technology it would employ to analyse the text of messages is no more intrusive than the technology used to scan e-mail messages for viruses and filter out spam.

It is unlikely that the Gmail controversy will backfire on Google, Yankee's Mahoney said. "While the scepticism was justified, I don't think the level of controversy was. After all, if you don't like Gmail, don't use it," Mahoney said. "If Google can pull this off in a non-invasive form and make consumers feel secure, there's a good percentage of consumers out there who won't care.

"It's basically all computer-generated scanning, so the invasive argument isn't necessarily the strongest argument against it, because there are other invasive e-mail technologies out there," Mahoney added. "However, consumers don't like to see a lot of advertising and that could be a problem. I see the service as being potentially more irritating than invasive."

The Google IPO filing had been widely expected to happen this week, when an SEC regulation would have forced the company, although privately held, to disclose financial information. Thus, the company would have regulatory disclosure hassles and paperwork without the benefit of an IPO's cash influx.

Google acknowledged this in its filing. "By law, certain private companies must report as if they were public companies. The deadline imposed by this requirement accelerated our decision. "

Google leads in search engine usage both in the US and globally, according to comScore. About 35% of internet searches in the US in February were done using Google. Yahoo came in second place with 30%, and Microsoft's MSN a distant third with 15.4%.

Worldwide, Google accounted for 43% of all searches, followed by Yahoo with 31% and Microsoft's MSN with 14.1%, according to comScore.

In terms of unique visitors, Google also rules among search sites, with just over 65 million US users visiting it in March, up 23.5% from March 2003, according to comScore. Yahoo's search site came in second, with 59.8 million unique visitors, followed by Microsoft's MSN search site with 49.9 million.

"Google is in a good position now because the company is thought of as a new and innovative brand. They made a market out of internet search, which people like MSN once thought of as laughable and not worth getting into," Mahoney said.

Google was founded in September 1998 by then Stanford University graduate students Larry Page and Sergey Brin, who are the company's president of products and president of technology respectively. Eric Schmidt is the chairman and chief executive officer.

As a privately held company, Google's primary financial backing has come from Kleiner Perkins Caufield & Byers and Sequoia Capital, which together led an equity round of $25m in June 1999, according to Google's website.

Juan Carlos Perez writes for IDG News Service

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This was first published in April 2004

 

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