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. (Here’s one notable exception.) 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. (My take is here, but unfortunately you need to subscribe to the Financial Times to read it.)
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.
This made money managers look a lot smarter than they were — even if you set the bubble aside, there are lots of fund managers whose returns from the late nineties need an asterisk next to them — and it wrecked the price-setting process, since there was no real attempt to let the price reflect the real demand for a stock. It also sabotaged one of the best things about capital markets, which is that in theory they aggregate the opinions of anyone with enough capital and enough risk tolerance to participate, and not just the opinions of those with the right connections. (There should be no velvet ropes in capital markets: if you can pay, you can play.) 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.