There are a number of unusual things about the public sale of shares in search behemoth Google Inc. the fact that it involves multiple-voting shares, for example, not to mention the long discourse in the company's prospectus on the virtues of "not being evil." But probably the most unusual aspect of the issue for many investors is the fact that it is structured as a "Dutch auction." Google's IPO is perhaps the largest test ever of this somewhat controversial underwriting method, at least for an issue of common stock, and even some securities industry insiders aren't sure exactly how it will turn out.
Most share issues by large companies in the U.S. use the underwriting method, in which a group of brokerage firms "market" an offering, with one or two firms controlling the process known as "running the book." The brokers survey mutual fund managers and other institutional investors to gauge their interest in the stock, and then they arrive at an offering price. In some cases, companies may use a method known as a "bought deal," in which the underwriters buy all the shares being offered outright and then sell them later, hoping they will make a profit on the deal.
By contrast, a Dutch auction is just what the name implies: an auction of stock, in which both institutional investors as well as retail investors make bids to buy shares at a particular price, often over the Internet. In a reversal of what takes place during a normal auction, however in which the seller tries to drive the price up a Dutch auction is completed at the lowest price necessary to sell all the shares. In other words, the offering company calculates how much money it wants to raise, and then chooses the lowest price that allows that to happen.
Google hasn't released the specific details about how it plans to structure its auction yet, but most analysts expect it to involve Internet-based bidding. WR Hambrecht, a brokerage firm founded by Bill Hambrecht - co-founder of former technology specialist Hambrecht & Quist -has taken several Internet companies public through its Internet-based Dutch auction process, which it calls OpenIPO.
As the name suggests, the Dutch auction was developed or perfected in the Netherlands, for the sale of tulips and other flowers, which make up more than a quarter of the country's economy. The auction at Aalsmeer, which has been going on since 1910, helps set prices around the world and is known as the Wall Street of flowers. In separate bidding rooms, the auctions use a special Dutch auction clock, which starts high and counts down the price of a particular-sized lot. The first bidder to make an offer wins the lot.
Dutch auctions are used for other things besides flowers. For example, many companies use the process when they are buying back shares of their own stock, as a way of setting a fair price for all shareholders. Commodities other than flowers are also often priced using a Dutch auction, and bonds are often sold through the process as well. The U.S. mortgage lender known as Fannie Mae (the Federal National Mortgage Association) sells billions of dollars in bonds using a Dutch auction.
When it comes to stocks, one of the benefits of a Dutch auction is that it removes the control brokerage firms have over a traditional IPO. In some share issues, the firms underwriting a deal have been criticized for low-balling the price in order to provide a "pop" once the stock begins trading. Sometimes this is done so that the stock gets lots of attention which often helps it climb even higher and so that insiders and institutions can unload some of their shares and see a nice return.
As a result, Dutch auction proponents say the process often results in the issuer getting more money up front for their shares than they would in a traditional issue. Underwriting firms particularly the ones running the book are also criticized for giving preferred clients access to IPO shares, which allows them to make a quick profit. During the late 1990s, this became widespread through a practice known as "spinning," in which CEOs of companies would receive preferential access to IPOs. The co-founders of Google said they didn't want this to happen, and didn't want to see large institutions get all the benefit from a price jump after the issue.
Although institutions could still wind up controlling a lot of the stock after a Dutch auction since they will be allowed to bid along with everyone else, and will likely be able to pay more the process reduces the chances that personal favouritism on the part of brokerage firms will determine who receives IPO shares. The way the price is determined also makes it less likely the stock will zoom higher once it begins trading, which should make it less appealing for short-term traders to flip it and make a quick profit.
That same feature, however, makes it less likely that the stock will rise at all after the offering. In fact, many issues that use a Dutch auction such as Internet retailer Overstock.com and on-line magazine Salon either stay flat or fall after they begin trading. That means any retail investors who are hoping to make a quick buck on Google's IPO could also be disappointed, although some analysts say there is so much demand for the company's shares that they will probably rise anyway.
In any case, if it is seen as successful, Google's IPO could help promote the benefits of an auction process still most associated with Dutch tulips.
© The Globe and Mail
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