WASHINGTON, May 10 (UPI) -- "La Grande Bouffe" (Blow Out), the cult 1970s French film in which a group of Beautiful People ate themselves to death on French food with occasional breaks for sex, may have its analogy this year in the forthcoming Google share issue, expected to value the company at $25 billion. The production values are wonderful, the cuisine exquisite and the experience doubtless sublime, but the underlying idea is revolting.
For a start, Google doesn't actually make any money, if you value the company on a "going concern" basis and take account of stock option issuance. You can't ignore stock options; without them Google's chief executive officer is paid $250,000, and he won't stick around long if you try to reduce him to that level! To be fair, Google doesn't ignore the value of stock options entirely; it takes account of the increase in value in each year of the stock issuable through options.
However, instead of expensing the whole such increase, it amortizes it over the next 5 years (on an "accelerated" basis, admittedly) thus producing a much lower number. In 2003, for example, Google's stock option cost on this basis was $541 million (the "value" of the shares rose sharply during the year), but only $214 million of this was expensed, while the remainder remained on the balance sheet as "deferred stock based compensation."
This won't do. Amortizing stock option cost over the next five years seriously distorts the picture, since you're not going to stop issuing further stock options during that period (if you did, your top management would resign.) For a mature company, it doesn't matter much, because stock option issuance presumably doesn't vary much from year to year; for a youthful rocket like Google it's very sharp practice indeed. Amortize stock option expense in the year it's incurred, and Google's 2003 net income of $106 million is more than wiped out, although it would still have achieved a modest net income in 2002 (albeit much smaller than the 2003 loss) since tech company values in that year increased little, reducing the value on this basis of issued stock options.
Google then gives brief information on its stock options' value under the proposed rule SFAS 123, requiring expensing of stock options values using the Black-Scholes valuation model or some similar method. It again amortizes the Black-Scholes value over a 5 year period, seriously depressing it in the pro forma income statement, and giving a spurious impression that mandatory expensing of stock options will have little effect on the company's financial position. However, another Form S-1 footnote gives the average Black-Scholes value of newly issued stock options at $2.79 per share in 2002 and $29.12 in 2003, from which you can calculate that the value of the 15.0 million options granted in 2002 and the 19.8 million granted in 2003 was $42 million in 2002 and $579 million in 2003, more than double the $22 million and $229 million respectively expensed in the income statements. The 19.8 million shares issuable through stock options in 2003, incidentally, represented more than 10 percent of Google's capitalization.
Needless to say, only 1.0 million options, with a Black-Scholes value of $67 million, were issued in the first quarter of 2004, far less than one quarter of the issuance in 2003. But then, in an initial public offering, one must expect at least a little bit of "window dressing!"
This is all just an everyday story of tech company greed, of course -- it makes you pity the poor fools who buy the issue on a $25 billion valuation (unless they're lucky enough to sell out fast to even greater -- and soon poorer -- fools.) Of course, their chances of selling out for a quick profit, usually pretty good in a tech sector IPO, are negated in this one because Google has chosen to throw out nearly 300 years of equity market wisdom (the South Sea Bubble share issues in 1720 were done the Wall Street way, and not Google's way) and offer shares by means of a "Dutch auction."
This has the advantage of cutting out some of the profits made by evil Wall Street bankers. It also has the disadvantage of guaranteeing losses to the investors themselves -- if 100 percent allocations of shares are made at the highest price at which buyers are prepared to bid, there are no unsatisfied buyers, and so early sales by speculators (in this case, misguided speculators) cause the share price to drop from the issue price and give all the IPO investors immediate paper losses. As I said, there's a reason Wall Street doesn't do share issues this way -- and the sight of billionaire tech promoters claiming moral superiority over mere millionaire Wall Street bankers is in any case pretty unattractive.
Indeed, there's something uniquely unpleasant in the hippie rhetoric with which Google surrounds its activities. "We aspire to make Google an institution that makes the world a better place" we are told in the early part of the S-1 statement (the only part that many journalists appear to have read!) "Google is not a conventional company" ... and, in an inspired moment of Bill-and-Ted-speak "Don't be evil." This kind of stuff is funny coming from 1980s high school kids, distasteful coming from 1960s hippies -- and deeply disturbing coming from 2000s billionaires benefiting from dodgy stock option accounting.
Of course, Google has built a better mousetrap, in the form of a more "intelligent" search engine -- and a more intelligent way of displaying advertisements. However, the superiority of its mousetrap may be ephemeral. It's very clear that both Yahoo (which recently pulled out of its joint venture with Google) and Microsoft have the company in their sights, and will not rest until they have carved very substantial chunks out of Google's market position and indeed profitability.
Since the total search page advertising market is currently worth only $3 billion, growing at only 20 percent per annum, according to the Economist, it is difficult to see where Google expects to produce a business that is genuinely worth eight times that amount, particularly since with a 2-tier share voting structure insiders will control the company ad infinitum.
Like most Internet issues of the late 1990s, the proposed valuation owes far more to hype than reality -- with the difference that, here in 2004, we have more idea of the true position than did the poor lost souls who bought Pets.com.
There is a deeper reason for skepticism about Google, which is the future of the Internet itself. Like the automobile and the electric power grid, the Internet has the potential to revolutionize human life, particularly in the area of knowledge management that is Google's specialty. At first sight, therefore, skepticism about Google's prospects may appear short-sighted, like the notorious U.S. Patent Office official who claimed in 1899 that all worthwhile products had already been invented.
There is one important difference, however. The automobile and electric power, once invented, became more reliable and easier to use, cementing their position in Western society and maximizing their contribution to our lives. This is not the case with the Internet. Far from becoming easier and quicker to use, it is becoming slower and more difficult as the tsunami of viruses, spam and pop-ups infest all interactions with it, either slowing productivity to a crawl or, if impermeable firewalls are used, causing many perfectly valid communications to vanish into the ether, thus cutting down severely on the reliability of e-mail.
While legislation has been passed attempting to control viruses and spam, it is ineffectual in achieving such control, since spammers can exist almost entirely in cyberspace. More sinister, it is now becoming clear that virus and spam producers are working in cahoots with at least some of the spam filter makers, so that consumers are forced into a Mafia-style protection racket in which you have to buy the filters in order to have even reasonably satisfactory use of the Internet. "Broadband" too, touted by President George W. Bush as an essential tool of technological advance for U.S. society as a whole, is becoming exponentially more sluggish, as the detritus clogs its arteries. Thus a consumer broadband Internet user of 2004 may experience Internet usage substantially slower than did a dial-up user of 1997, before pop-ups, spam and viruses became so universal.
It's possible that a solution will be found to the virus/spam/popup problem before it gets very much worse, and the Internet will continue to be an essential information artery into the homes of America. It is also however possible that such a solution will not be found, so that the quality of Internet communication continues to deteriorate, and its costs to increase.
In the latter case, the consumer must inevitably at some point rebel, as the inconvenience and unpleasantness of using the Internet comes to outweigh its advantages. Large companies will move to an Intranet, in which information sources are purchased from third parties and kept in an in-house system, safe from outside attack. Home users and small businesses, in such a case, may find that using the Internet becomes simply unproductive, at which point, with relatively little damage to their lifestyle, they will stop doing so, relying on DVDs and CD-ROMs for the information and entertainment they need. If this begins to happen even to a small extent then the "network effect" on which the Internet depends may go into reverse, as the "early adopters" become early un-adopters, and a readily available e-mail address becomes like a telephone number in the local directory, something that the truly cool don't have.
In 1950, the insecticide DDT seemed a miracle product, that could finally wipe insect-borne disease out of the Third World. In 1960, aerosol spray can deodorants appeared a great advance in civilization, allowing you to remain "fresh" even through a Washington summer. In the late 1950s, thalidomide appeared a pharmaceutical breakthrough. All three products, in the end, proved to have deadly side-effects that were more important than their advantages, and were therefore made illegal and withdrawn from the market.
Technological advance is a truly wonderful thing, but it is not inevitable, often has unforeseen effects, and doesn't proceed in a straight line. Like La Grande Bouffe, the Google IPO may eventually be seen as a quaint but ultimately nauseating artifact of its era.
(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
Martin Hutchinson is the author of "Great Conservatives" (Academica Press, June 2004) -- details can be found on the Web site greatconservatives.com.
