An Analysis of Google´s Controversial New Share Structure
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Google (NASDAQ: GOOG) reported earnings results were a bit better than estimated last Thursday, however, most analysts and commentators are focusing their attention on the company´s new share structure. That´s understandable considering that those kinds of moves are more important for long term investors than sales or earnings during any particular three month period. Are minority shareholders being ripped off by Google´s polemic stock split?
That seems to be the opinion of many in the financial press and, considering that shares of Google fell by more than 4% on Friday after the announcement, we could say that investors didn´t take the new decision with benevolence. A negative initial reaction is really no big surprise; the move was unexpected and accentuates the founders´ control over the company, which has always been very strong anyway. However, taking a deeper look, the new share structure doesn´t look like a big game changer for shareholders.
Google is issuing a new class of shares – class C – which won´t have any voting rights; investors will receive a new class C share for each class A stock they own, in what could effectively be considered some unusual kind of stock split. Future equity grants for Google employees as well as shares issued for corporate acquisitions will be done in the new class of shares.
According to management, the decision was taken in order to avoid outside influence on the company´s strategic directions. Shareholders can sometimes be too centered on short term profit numbers instead of long term product development, which may imply investments with no economic returns for long periods of time. According to Google´s founders, they are simply trying to make sure about the fact that no one will exert an undue influence on their long term strategic directions.
Keeping in mind the fact that the founders own shares of class B stock, which have 10 voting rights each in comparison to 1 voting right for each class A share, there doesn´t seem to be any rush to implement such a decision. Google would have to almost double the amounts of shares currently outstanding for Page, Brin and Schmidt’s combined voting stake to slip below 50 percent.
From Google´s founder´s letter on the issue:
We have protected Google from outside pressures and the temptation to sacrifice future opportunities to meet short-term demands. Long-term product investments, like Chrome and YouTube, which now enjoy phenomenal usage, were made with a significant degree of independence.
We have a structure that prevents outside parties from taking over or unduly influencing our management decisions. However, day-to-day dilution from routine equity-based employee compensation and other possible dilution, such as stock-based acquisitions, will likely undermine this dual-class structure and our aspirations for Google over the very long term. We have put our hearts into Google and hope to do so for many more years to come. So we want to ensure that our corporate structure can sustain these efforts and our desire to improve the world.
It’s important to bear in mind that this proposal will only have an effect on governance over the very long term. In fact, there’s no particular urgency to make these changes now—we don’t have an unusually big acquisition planned, in case you were wondering. It’s just that since we know what we want to do, there’s no reason to delay the decision.
How does this affect shareholders?
First of all, current shareholders are not losing any of their voting rights, since the current balance of voting power won´t be changed at all by the new structure. Over time, however, holders of class C stock will have full economic rights but no political power in the company.
Individual shareholders don´t usually hold a big enough position that may allow them to move the needle when it comes to strategic decisions, so their situation won´t change too much. Also, class C shares should trade at a discount to class A stock, so those interested in benefiting from the company´s growth without trying to influence its managerial decisions could find a convenient alternative in the new class of stock.
On the other hand, the founders have guaranteed their majority voting power over the long term, which could bring some conflicts in case there are some important issues in which the founding team and shareholders disagree. Of course, it´s never easy to tell if the best for the company is what Page and Brin decide or if the rest of the shareholders will have a more sensitive opinion.
I have written about the many things that Google seems to have learned from Apple (NASDAQ: AAPL) in this post, and the new share structure may very well be another one of the lessons learned from Steve Jobs. Jobs was expelled from Apple when the board of directors sided with John Sculley in a decision that turned out to be extremely detrimental for shareholders and almost brought Apple to its collapse.
Google´s founders have always had a strong control over the voting rights in the company, and the new share structure doesn´t do anything else than cement that control over the long term. An investment in Google is necessarily an investment in its management team, investors who disagree with their decisions should probably sell their shares instead of trying to force a change of direction.
Things haven´t changed that much with the new share structure, unless Page and his team make any rough moves like a big acquisition financed with shares, which they explicitly stated they wouldn’t do. Overall, this unusual stock split is no reason to sell Google shares.
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