|
 Brin and Page have changed the world and created a cash flow
behemoth in Google. Human nature, on the other hand, has created
every other conglomerate, which, with the possible exception of
Berkshire Hathaway, have a general record of capital misallocation
and underperformance.
Alphabet, of course, is the new holding company Brin and Page have
created, and will head, which will comprise both Google and their
far-flung and growing list of other companies working on everything
from longevity to contact lenses that can measure blood glucose in
diabetics.
This isn’t so much Google, or Alphabet, becoming a conglomerate as
codifying how its collection of companies and investments will be
managed. The new structure offers certain advantages, freeing the
co-founders to concentrate on 'moonshot' efforts while cleaning up
lines should it want debt finance.
None of this should be a surprise. Page and Brin have always been
upfront about not managing for shareholder value maximization. And
last year they created an additional class of shares, one which, as
it has no voting rights, will allow them to raise capital and reward
executives but lose control over the direction of the company at a
slower pace.
So, then, a conglomerate, with all that implies, and one with
multiple share classes insulating the founders from the will of
shareholders. What, as they say, could possibly go wrong?
Investors in publicly traded companies have a hugely diverging set
of options these days, few of them particularly satisfying from a
shareholder’s point of view. On the one hand you have far too many
companies which are giving financial engineering, usually via share
buybacks, precedence over investment in their core franchise. That’s
problematic because investors risk seeing that franchise hollowed
out over time as manager prioritize making quarter-by-quarter
increases in earnings, even illusory ones, over building.
On the other hand you have the mad builders, of which Alphabet nee
Google is a prime example. My reservation isn’t whether the core
cash flow machine Google, which produces some $20 billion annually
in operating cash, is fairly priced.
Instead it is who gets a shot at the fruits of those profits, and
how. To want to buy Alphabet, and clearly many do, you have got to
be willing to give up a lot of customary protection in exchange for
access to their world-changing genius.
TALE OF THE TAPE
While quite a few technology companies such as Alibaba and Facebook
have dual or multiple share structures, the man making the most
convincing, at least to the market, argument for the conglomerate is
Warren Buffett, whose Berkshire Hathaway is just that, and has a
long record of success.
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Buffett stands in contrast to Brin and Page, offering discipline and
patience as a capital allocator where they offer inspiration and 'moonshots'.
Warren, after all, would never try to tell you that Dairy Queen will
help you live to 150, only that it is a business which can be
profitable over the long term if managed well.
So both companies are votes on exceptionalism, Buffett’s or
Alphabet’s.
The rules which make the exceptions in conglomerates and multi-share
class companies meaningful, however, are not encouraging.
Conglomerates as a group trade at a structural discount to intrinsic
value, a phenomenon which has gone on so long it even has a name,
the ‘conglomerate discount’. This discount in 2012 stood at about 10
percent, according to Boston Consulting, a bit less than the 14
percent or so average since 1990.
That’s because conglomerates have a poor track record of capital
allocation, being prone to supporting executives' dreams of empire
rather than taking a gimlet-eyed view of return on equity.
A 2012 study by Institutional Shareholder Services, funded by the
Investor Responsibility Research Center Institute, found that
tightly controlled companies - especially those with multiple share
classes - generally underperform over the longer term. (http://irrcinstitute.org/projects.php?project=61)
All of this is as unshocking as it gets. Human nature argues that
Alphabet, and perhaps even Berkshire Hathaway, will be likely to
fall prey to the same shareholder-damaging behavior that undermines
the groups of which they are emblematic.
Some might conceivably feel they just can’t afford not to be exposed
to Alphabet.
I myself am glad they are doing this investing, some of which may
lead to exciting or even world-changing businesses. I am gladder
still they are doing it with someone else’s money.
(At the time of publication James Saft did not own any
directinvestments in securities mentioned in this article. He may
bean owner indirectly as an investor in a fund. You can email him at
jamessaft@jamessaft.com and find more columns at
http://blogs.reuters.com/james-saft)
(Reuters) - (James Saft is a Reuters columnist. The opinions
expressed are his own)
(Editing by James Dalgleish)
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