Monday, August 23, 2004

Seeing Success and Calling it Failure, and Vice Versa

Marginal Revolution guest blogger James Surowiecki offers a helpful corrective to the notion currently making the rounds that Google's IPO was either some sort of "failure" because the stock "only" rose 18% on opening, or a "shining" success because it offered those who were lucky enough to put in a bid a chance to make an astronomical annualized return simply for holding the stock for a single day. In reality, such a substantial opening-day rise indicates that Google insiders actually left money on the table that they needn't have, simply to satisfy the greed of investment bankers and the silly expectations of ignorant journalists.

In the weeks leading up to Google's IPO, few people had anything good to say about the company or its decision to go public using a modified Dutch auction ... But now we're seeing a welcome backlash to the anti-Google backlash, with a host of articles arguing that, glitches notwithstanding, the IPO worked ...

Most discussions of the IPO have focused, appropriately, on the fact that Google maximized the amount of money it raised by reducing the commissions it paid its investment bankers and by getting itself a fairer price than it would have under the traditional system. (Even though Google's price did jump 18% on the first day, that was a relatively reasonable discount given all the fear and uncertainty Wall Street had tried to sow about the company and the offering.) As Alex wrote last week, the true test of the success of an IPO is the "cost per dollar of raised funds," and by that standard Google did well.

But the offering was also a success for another reason, which is that it forced institutional investors to compete, for once, on a level playing field. The problem with the current IPO system isn't just that companies end up leaving billions of dollars on the table when they go public, but that select mutual-fund and hedge-fund managers (as well as well-connected individuals) are handed what amounts to free money. In a traditional IPO, the investment bank underwriting the offering controls the allocation of shares. In the late 1990s in particular, that allocation process became a way of doling out favors and securing future business. For instance, if you were a mutual-fund manager who funneled a lot of trades through an investment bank -- or who agreed to do so -- then you were more likely to get a hefty allocation of IPO shares.


Google turned all this around: the only way to get shares in the Dutch auction was to do the valuation work and make a reasonable bid. The traditional IPO relies on the power of cronyism. Google's IPO, flawed as it was, relied on the power of markets. Bad for the Street, good for everyone else. (emphasis added)
Surowiecki nails it on the head when he mentions the "fear and uncertainty", or, to use the traditional terminology, the FUD, that Wall Street types have been hard at work stirring up about the IPO. They at least have eminently rational albeit selfish reasons for doing so, but what really gets me is that so many mainstream news organizations should have gotten the story so spectacularly wrong; in the BBC's case, what it calls a "shining" second day of trading is actually an indicator of how successful the rumor campaign against Google's offering was, which is hardly a thing to be celebrated.

Is it really asking so much to expect journalists covering financial affairs to at least go on a month-long grounding course on the basics of the field they're going to cover? It hardly takes an MBA or a Masters in Finance to understand such elementary matters, after all.