Wednesday, August 19, 2015

Google and Its New Alphabet

From out of the blue, Google reorganized itself into "Alphabet" 
Google caused heads to turn, right in the middle of summer when corporate managers, business leaders, bankers, traders and investors had their minds on Chinese currencies, Republican presidential candidates and a possible beach vacation.

The company announced a reorganization and a name change at the holding-company level, explained its strategy in terse press releases and then left it to equity markets to figure out what all this implies.

The market responded favorably with a large spike in share price, as bits of details unfurled from Google's Mountainview headquarters. The most notable reaction has been analysts wondering out loud whether Google reorganized itself into a West Coast version of Warren Buffett's Berkshire Hathaway, a holding company with a large portfolio of large, diverse companies.

Others have ventured that Google is replicating an organization model similar to General Electric, a holding company with several operating companies within similar industries. The eldest analysts and observers contend Google decided to bring back the popular conglomerate models of the 1960's and 1970's (ITT being the best example of that era). Finance professors, theorists, and historians have debated for decades about the pluses and minuses of conglomerates. Are investors better off, they argue, bearing the responsibility to diversify a portfolio themselves?

At Google, a lot is happening structurally. And a lot isn't. The name change at the top surprised many. (Did anyone outside the board room and Google's cadre of lawyers and advisers see it coming? Could anyone have speculated the new name would be "Alphabet"?) Few, if anybody, had projected that Google would "downstream" its untouchable brand name into a main operating subsidiary and then adopt the unforeseen "Alphabet" title at the top. Some might have recommended all along that  a reorganization of some kind would occur eventually.

Alphabet Raises Eyebrows

If anything, a new title at the holding company lets analysts and the public know this reorganization was more than a rearranging of organization chairs. It got people's attention. If there had not been a name change or if the new name had been a variation on "Google," then many might have dismissed the announcement as nothing more than a late-summer business press release.

While not much has changed in operations and people, the reorganization unleashed value (the upward bump in the stock price is evidence) because it permits investors to understand the company's businesses, its new investments, and even its long-term dreams more quantitatively and, in the main Google unit, with more certainty. The reorganization will help analysts understand the financials and appreciate, too, how sturdy and sound the search-engine side of the company has been and will continue to be.

Analysts and investors won't need to guess at the contributions from the search-engine operation (Google in the new organization) and fathom how much all the experimental businesses (drones, driver-less cars, thermostats, etc.) might be a financial drain. They can determine better when in the future the dream businesses will begin to reap returns. There is a basic tenet in corporate valuation. When investors and analysts don't on guesses or are not befuddled or strangled by uncertainty, intrinsic value rises (and so do stock prices).

Buffett's Inspiration?

As much as the media invoke Buffett, the reorganization doesn't replicate a Berkshire Hathaway model, although Google's founders Larry Page and Sergey Brin acknowledge having been inspired by Buffett's approach. Buffett pounds the pavement looking for the next value investment (which he found in the aerospace industry in a blockbuster deal in the past month). Investments range from railroads to insurance, from financial institutions to beverages.

Google isn't evolving into a similar conglomerate with passive investments in a dozen or more established companies, many with hundred-year-old products.  It is realigning into the proven and the unproven, separating out the research laboratories and generally remaining in a broad technology-oriented sphere.

Google, until the announcement, is a $66-billion-revenue company, growing lockstep each year, generating earnings exceeding $13 billion (good enough for ROE's that climb above 14%). Company investors enjoy the predictable growth and seem satisfied that dividends and stock repurchases aren't promised or don't seem to be on the horizon.  Hence, the company's $18 billion cash flow (last year) permits it to use over $10 billion to reinvest in new projects, as it did in 2014, and hoard the rest until the next new idea comes along.  (The company hardly relies on debt.)

The company, after the announcement, will continue to reap billions in cash from the Google unit, some of which can be siphoned off to support the ideas of its sibling units.  The restructuring allows investors to see precisely where the cash comes from and where it is going. It may also keep shareholder activists from barging in to demand hefty dividend payouts, if they see the analytics of where cash is being reinvested.

Investment bankers, nonetheless, wait in the wings, always looking for other ways to unleash more value for the company (valued at $465 billion this week). Somehow some will eventually tap the Page-Brin  duo on their shoulders--not now, but perhaps a few years from now--to convince them that shareholders would be better off if the new Google unit (the search-engine unit, which includes YouTube) were spun out. Watch.

Tracy Williams

See also:

CFN:  Twitter's Turn for an IPO, 2013
CFN:  Alibaba's IPO, 2014
CFN:  Yahoo:  Will It Rebound? 2015
CFN:  Verizon and AOL, 2015
CFN:  Dell Goes Private, 2013

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