NEW YORK (CNN/Money) -
If you didn't get a chance to register for shares of Google before it goes public, don't worry.
And if you're tempted to buy shares of the company once it finally starts trading, which will probably be next week, here's my advice. Don't. At least not for a couple of weeks.
Why such pessimism for a company whose technology everybody seems to love? Is it because Google is destined to become another theglobe.com or VA Linux, a stock that shoots up to absurd heights on its first day and never trades in that rarified air again? No.
In fact, because the pricing for the offering is being set through a Dutch auction process, shares will probably only experience a modest gain at the open.
"The stock is going to go up 5 to 10 percent the first day. It's not going to go up 50 percent or more," said Ethan McAfee, director of research with Capital Crossover Partners, a hedge fund.
Google, to its credit, is doing its best to ensure that shares don't have a helium-infused opening pop.
The problem, however, is that even if the stock trades at the low end of its preliminary price range of $108 to $135 a share, it would still be trading at an incredibly rich valuation.
The bidding process will ultimately set the final offering price. But let's say that the stock winds up at the low end of $108.
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Mark Mahaney, an analyst with American Technology Research, an independent research firm, said that at $108, Google would be trading at about 19 times his 2005 cash flow estimates. He argues that Google should trade at a 25 percent discount to top competitor Yahoo! (YHOO: Research, Estimates), since it is a more diversified company.
But Yahoo! is currently trading at about 21 times his 2005 cash flow projections. So Google, at the low end of its price range, would be valued at just a 10 percent discount. At the $121.50 midpoint, Google would be trading at a cash flow multiple in line with Yahoo! And at the high end of $135, Google would be getting a nearly 15 percent premium.
"Maybe the market wants to pay that, but I wouldn't want to do that," Mahaney said. He thinks a fair value for the stock would be between $95 and $100 a share, which would put Google at about 17 times 2005 estimated cash flow.
Patience is a virtue
Investors also need to remember that Wall Street's love affair with IPOs is often fleeting. The transition from being a private company beholden to a small group of venture capitalists to a public firm subject to the fickle whims of individual investors, mutual funds and hedge funds is frequently tough.
To that end, what's going to happen to Google when it reports its third-quarter results in October?
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| Google is looking to go public at a time when investors have lost their appetite for Net stocks. |
Since Google is going to command a premium multiple, there will be a lot of pressure on the company to deliver extremely strong sales and earnings numbers. That could make Google highly volatile, which is why McAfee said his firm is steering clear of the stock.
"The valuation is too steep. I'd rather invest in a company that everyone hates, which trades at 15 times next year's earnings," McAfee said. "If Google traded at a reasonable valuation, I would own a ton of it, but if it misses numbers at these valuations it could fall sharply in a day."
There are other reasons for investors to be patient. A flood of Google shares is likely to hit the market within the next few months, which would lead to selling pressure on the stock. Newly public companies have what is known as lock-up expiration periods, dates when company insiders and employees are allowed to sell their shares.
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Google is only planning to sell as much as 29.6 million of its total 271.2 million shares outstanding in the IPO. But according to the company's latest prospectus, an additional 4.6 million shares will become eligible for sale within 15 days of the completion of the IPO, while another 39.1 million shares are eligible within 90 days after the offering. So Google employees might want to cash in. And who could blame them?
"If you're a good financial planner and your client works for Google, you should be telling them to take some money off the table. But that's a risk factor for investors," said John Tinker, an analyst with ThinkEquity Partners, another independent research firm.
Sure, Google's business of search-based advertising is incredibly hot. And the company is widely acknowledged as having the best search technology. But Yahoo! is becoming a tough competitor. So is a little company called Microsoft, which should give even more details about its search plans in the coming months. And that could lead to some sell-offs in Google as well.
"Microsoft is one focused company, and it is taking Google very seriously. MSN is profitable so it makes it easier for them to reinvest in it. Search is not a peripheral project. That has to make investors nervous," Tinker said.
With all this in mind, it makes sense for investors to not go Googling for the IPO just yet. The stock could very well be a better bargain in a few months.
Analysts quoted in this story do not own shares of companies mentioned, and their firms have no investment banking ties with the companies.
CNN/Money has a business relationship with Yahoo!
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