Google IPO Primer

When Internet search site Google filed its long-awaited plans to sell shares to the public last week, it set off a flurry of analyses about the outcome of the IPO as well as the past and future of the company. So, what does this all mean for investors?

The Buzz Behind Google

Google was founded in 1998 by Larry Page and Sergey Brin, who are purported to own one-third of the company. Venture capital firms Kleiner Perkins Caufield & Byers and Sequoia Capital Partners also own a portion of the company, as does Google's rival, Yahoo! Inc.

The moniker Google is derived from "googol," which is the term for the number 1 followed by 100 zeros. Google's founders chose this name to "reflect the company's mission to organize the immense amount of information available on the Web."

With more than 200 million searches conducted every day, Google has emerged as the Web's most popular search engine, accounting for more than 41 percent all of search queries, according to WebSideStory. Although the company refuses to reveal exact details about its operation, it is estimated to employ more than 1,000 people — known as Googlers — and runs on a network of more than 100,000 servers worldwide.

How Does Google Make Money?

Google makes money by selling targeted ad space alongside individual search results. After five years in business, the company is generating close to $1 billion in annual revenue from the ads placed on its Web site and the sites of its partners. Recently, it has expanded its business to include an e-mail service, Gmail, which distinguishes itself by allowing users to quickly locate their messages, which are housed on Google's servers.

IPO 101

An IPO, or initial public offering, represents the first time a company issues stock to the public, hence the term "going public." Essentially, an IPO represents the first opportunity to purchase ownership (i.e., stock) in a company that has been privately owned. When a private company decides to go public, it hires a lead underwriter, typically an investment bank, which serves as a middleman of sorts.

The underwriter buys all shares of stock the company is selling and then sells them on the open market. The underwriter is also typically responsible for setting the price at which shares will be offered on the first day of trading, and the price is usually related to the demand for the stock. With regard to the Google IPO, Morgan Stanley and Credit Suisse First Boston are the lead underwriters in the sale of its IPO shares.

Prior to the actual IPO, the company and underwriter need to accomplish several things, including notifying prospective investors of the upcoming IPO in "tombstone" advertisements in the financial press and filing a "red herring" prospectus with the Securities and Exchange Commission.

"Tombstone" ads provide the name of the company, the number of shares to be offered, the price per share and the name of the underwriter(s). A "red herring" prospectus derives its name from the red ink label on the cover of the prospectus warning prospective investors that the information is incomplete. Basically, a red herring outlines the history of the company-including its industry, competition and financial strength — as well as its business plan moving forward, taking into account how it will use the proceeds from the IPO.

IPOs for the Average Joe

Although there is quite a bit of hype surrounding IPOs, it is usually difficult for an individual investor to buy an IPO. Investment banks generally sell IPO shares to money management firms and other favored clients.

However, ever an innovator, Google is proposing to structure its IPO to enable almost anyone to get a piece of the action. Specifically, the company will sell shares through a "Dutch auction," which means a fixed number of shares would be sold directly to the public at whatever price institutional and individual investors are willing to pay.

While individual investors would most likely need to purchase shares through a broker, they could have access to the Google IPO through this system, which is still relatively unusual in the United States. In fact, fewer than one dozen companies have used the Dutch auction system to go public over the past several years. Most recently, Peet's Coffee & Tea and used similar auction methods to launch their respective IPOs.

While the Dutch auction enables smaller investors to get into the action, Google stock could be in for a volatile, wild ride. Often, the winners of the auction will try to immediately unload their stock to make a quick profit.

In case you're considering getting in on the action, here are some things you might want to think about:

What could the value of the business be? Google already takes in close to $1 billion in annual revenue. The company reported operating profits of $347.6 million in 2003. Currently, it is estimated Google might be worth $15 billion to $30 billion after the public stock offering.

Where have all the IPOs gone? In the 1990s, an average of 155 tech companies went public every year. In 1999 alone, 295 U.S. tech and Internet-related startups went public raising more than $34.6 billion. However, the IPO market has been on the decline since 2001. For example, there were only nine tech-related IPOs in 2002 and 17 last year. In total, 2003 saw the fewest IPOs in the United States since 1979.

Is Google a good investment? Technology, as a whole, is often a risky investment because of competition and the potential for obsolescence. In Google's case, the license on its proprietary search engine technology expires in 2011 — in effect, opening doors for competitors like Yahoo! and Microsoft.

Furthermore, of the 10 IPOs with the biggest first day surges since 1975, not one ever returned to the price it received in the first day, according to an analysis of data from Jay Ritter, professor of finance at the University of Florida. Past hot-issue IPOs like AT&T Wireless which came out to significant public fanfare in the year 2000 faded fast. Despite a strong brand and quickly growing market, the stock fell from its initial price of $35 and steadily declined and dropped below $4 a share in October of 2002. Although Cingular eventually acquired AT&T Wireless for around $15 a share, it was at a significant reduction from the original IPO price.

That said, most amateur investors should be very cautious when investing in an IPO. Without an established track record and a clear earnings history, it can be a speculative and risky investment.

Mellody Hobson, president of Ariel Capital Management ( in Chicago, is Good Morning America's personal finance expert. Ariel associates Matthew Yale and Aimee Daley contributed to this report.