Friday, April 13, 2012

Google splits its stock and spits on its stockholders


I have talked about Google in prior posts on its voting share structure and the increasing cost it is paying for maintaining growth. Well, the company had a big news day yesterday, starting with an impressive earnings report (earnings growth of 60% & revenue growth of 24%) and ending with an announcement that they would be splitting their stock, with a twist. I will focus on the stock split but use it to also make a couple of points about corporate control and earnings growth.

Stock splits and stock dividends are empty gestures from an intrinsic value standpoint because they change none of the fundamentals of a company. The value of a business rests on its capacity to generate high returns (and cash flows) from existing investments, its potential for value creating growth and the risk in its operations. Splitting your stock (or its milder version, stock dividends) change the number of units in the company without affecting value. Thus, in a two for one stock split, you, as a stockholder, will end up with twice the number of shares, each trading at half the intrinsic value per share that they used to.
The Google split: Google’s intrinsic value does not change as a result of the stock split. If you are interested, here is my estimate of the intrinsic value per share of Google,, pre-split. At $630/share, the stock look a little over valued (by about 10%). After a two for one stock split, they will still be over valued (by about 10%)... 

There are two areas where stock splits or dividends can affect prices, either positively or negatively.
a. Price level effects: By altering the price level, a stock split can affect trading dynamics and costs, and alter your stockholder composition. The “splits are good” argument goes as follows: when a stock trades at a high price (say $800/share),  small investors cannot trade the stock easily and your investor base becomes increasingly institutional. By splitting the stock (say ten for one), you reduce the price per share to $80/share and allow more individuals to buy the stock, thus expanding your stockholder base and perhaps increasing trading volume & liquidity.  The “splits are bad” argument is based upon transactions costs, with the bid-ask spread incorporated in these costs. At lower stock price levels, the total transactions costs may increase as a percent of the price. The effect has been examined extensively and there is some evidence, albeit contested, that the net effect of splits on liquidity is small but positive.
The Google split: Since the split is a two for one split at a $650 stock price, there is not much ammunition for either side of the price level argument. At $325/share, Google will remain too expensive for some retail investors and the transactions costs and trading volume are unlikely to change much. As one of the largest market cap companies in the market, I don't think liquidity is the biggest problem facing Google stockholders.

b. Perceptions: A stock split may change investor perceptions about future growth potential in both good and bad ways. The “splits are good” school argues that only companies that feel confident about future earnings growth will split their shares, and that stock splits are therefore good news. The “splits are bad” school counters that splits are empty gestures (and costless to imitate) and that companies resort to these distractions only because they have run out of tangible ways of showing growth or value added.
The Google split: I would find it odd that a company that just reported good growth in earnings and dividends would use a stock split as a signal. In fact, I am looking forward to seeing the full filing. Perhaps, there is “bad” news hidden behind the healthy growth that Google does not want me to pay attention to.. Or, Google is looking down the road at the oncoming competition (from Facebook and its social media allies) and does not see good things happening. Or, maybe a split is sometimes just a split (with no information about the future)... 

The twist in this stock split, i.e., that the shares that will be created in the split will have no voting rights, is the more intriguing part of the story. In talking about the rationale for the split, here is what Larry Page said:
"We have protected Google from outside pressures and the temptation to sacrifice future opportunities to meet short-term demands." Talk about chutzpah! What outside pressure? And to do what? And what temptation is Page alluding to? Brin and Page think that you (as stockholders) are too immature to know what’s good for you in the long term, and they want to make these decisions for you.  I think it is absurd to make the argument that Google would somehow have been stymied in its long term decision making, if it did not have the shareholder structure that it has now. I will wager that there is not a single decision that Google has made over the last decade that they would not have been able to make with a more democratic share voting structure (one share, one vote). The difference is that they would have had to explain these decisions more fully, which is a healthy thing for any management in a publicly traded company to do. In fact, what the stock split signals (to me) is that Google is planning more controversial (and debatable) big decisions in the future and they do not want to either explain these decisions or put them up for a fair vote.

As the Google model for control becomes the rule rather than the exception, at least in the technology sector, here are the three responses you can adopt to the "Googlers":
a. Sit it out: If as a stockholder, you are becoming part owner (and partner to the current owners) of a business, I would not blame you, for refusing to buy stock in Google-like companies, because you are not being treated as a full partner. Consequently, you could decide to avoid being investors in any company that has a dual-class structure for voting. The problem, of course, is that you might end up with no investments in an entire sector (social media and young technology) that is the fastest growing segment of the market.

b. Price it in: The logical response to the loss of control is to price it in, effectively discounting the price you pay for low-vote or no-vote shares, relative to full-vote shares. Conceptually, it is not difficult to do and I have a paper on how you can go about estimating the discount on non-voting shares: you have to build in the expectation and likelihood that managers will misbehave in the future, and that you will not be able to stop them.  In practice, though, investors often value low-vote shares  based upon recent management performance/behavior, paying too high a price when managers are behaving and performing well and pushing down the price too low, after managers disappoint them. 

c. What, me worry? There are investors who argue that  owning shares, with or without voting rights, gives you little say in the management or corporate governance of most companies and that the dilution of voting rights should therefore have no effect on what you should pay. My response to this karmic view of corporate governance is two fold. First, the fact that you may not be able to change managers with your shareholding (because it is small) does not necessarily imply that stockholders collectively cannot make a difference; in fact, we know that they often do. Second, if you buy into this view, you have effectively lost the right to complain about your lack of say in decision making. Thus, for those institutional stockholders in Google who were quoted in the news stories yesterday as being disappointed that your counsel was not heard, I have little sympathy for you. Google and all of its imitators in the technology sector (with Facebook being the most prominent recent member of the “spit in your stockholder’s face club) have been clear about where control lies. Buying stock in Google or Facebook and then complaining about the autocratic tendencies of Page/Brin or Zuckerberg is like getting married to one of the Kardashian sisters and then complaining about your in-laws or loss of privacy. (Let's call this the Kardashian rule and codify it....)

20 comments:

millssnell said...

Excellent article. Thanks for the insight and perspective into splits and helping shed light on the myth that splits are always good for value.

Miguel C said...

Professor,

Excellent article. But I have a question for you: Do you think that tech companies are going to ruin some of the corporate governance rules won by investors over time? Do you see a new terrible trend on that?

Aswath Damodaran said...

Yes, but I think we get the corporate governance we deserve. As long as we do not punish companies that do this, as investors, why would they do anything different?

Colin said...

I Agree. Arrogant move by google.

Anonymous said...

Why do regulators accept this. Differential votin rights, amount to the holder of the voting shares saying that we reserve the right to abuse the minority. It is not good governance & it is a failure of regulations.

I suppose an instrument which packages what amounts to a sale of voting rights may be okay; say something where all holders have equal economic rights except that share holders with no voting rights have superior rights (both first rights [eg. buybacks first for non voting shares] as well as premium rights [perhaps a minimum dividend of 2% subject to availability of distributable profits and additional dividends at 10% premium to that paid to voting shares]) with respect to capital returned.

Anonymous said...

Splits & Stock dividends will not influence intrinsic value, but there are forces that allow external gains which can be realized by shareholders to get embedded in the price of the stock; albeit for a limited time.

For example, some jurisdictions will create a tax advantage post bonus. Or initial buying interest on a lower share price may drive share prices up; it may allow for better price discovery but more likely its will be a spike caused by increased short term demand.

Shiv said...

Would you call Warren Buffet an evil old man. He pays less tax than his secretary & reserves the right to exploit his minority shareholders through BRK B shares which carry low voting rights. Its better only by degree compared to GOOG. Perhaps Buffet can be trusted; he has earned it. But is a structure which permits explotation of minority sensible succession planning? How would Sokol have handled the power? Its bad governance & regulators should not permit it; they must act when shareholders wont.

Aswath Damodaran said...

Evil is too strong a word to be throwing around. How about motivated by self interest, as we all are?

Anonymous said...

Thank you for the article. One small (potentially naive)question on your Intrinsic Value excel of Google: Should you use MV Debt as opposed to BV of debt when calculating the equity value? (maybe BV=MV in this case, not sure).

Thanks for your time.

MOHIT said...

Prof Aswath,

In addition to the two areas of impact of stock splits you have talked about, I'd like to propose a third.

Could it be that Google, through its split is actually inviting a certain profile of investor - someone who is ok with the company taking big risks in the short term for long term disproportionate gains. Assuming that this works, over a period of time Google's shareholders will predominantly belong to this type, and the rest will leave for more suitable pastures. This in turn could bring some stability to Google's stock price. (It's a bit like your argument about Apple attracting the WRONG kind of investors through dividends. Could Google be trying to attract the RIGHT kind of investors?)

Regards,
Mohit

M Chitnis said...

Prima facie, this concentrates voting power but presumably has no effect on the static value of stock.

Thinking about it from another angle: clearly, part of the value of an equity comes from the voting power. How does this impact the dynamics of the value of a vote embedded in the equity?

In such a structure, esp. where the superclass shareholders have ability to issue additional no/low vote-class shares, I would think that the superclass has the power to increase the embedded value of the vote (which they own) simply by issuing more no/low-class shares. In this way, can they transfer value from other classes to themselves? And, if so, is his not minority shareholder oppression?

PRATEEK PODDAR said...

Prof Damodaran,

Excellent article.However if the non voting shares are quoted at a discount to the voting shares post split cant minority shareholders arbitrage the same and earn a gain.A minority shareholder as it is cant have much say in the working of a company so he is better off buying non voting right shares than one with rights

Anonymous said...

Excellent analysis, however a bit out of place for the present time.

GOOG has given an option to the shareholders. If you do not approve their governance, you can run for the exit and invest somewhere else.
And they are forthright in their announcement.

Compared to the Wall street firms (Goldman et al), GOOG management appears harmless. The Goldman thugs are destroying the world economy with their shenanigans. Using derivatives, they helped Greece govt. hide their debt and god knows where else they are looting the public. However, very little is known about this.

Professor, why don't you write about this and educate people? The biggest danger of the time is sovereign debt/default. Compared to this, the GOOG incident is nothing.

Raghavendra A Ravuri said...

GOOG split has to do anything with implications of forthcoming facebook ipo!!!

Anonymous said...

Curious, does this stock split affect the employees of Google who have stock vesting plans awarded as part of the compensation?

arsene lupin said...

given that large pension funds are passive shareholders - one feels like one is choosing between ceding control to activist shareholders (e.g. the Icahns of the world) and founder-owners. if you buy that (slightly jaded) point of view - founder-owners generally seem to come out ahead ..

Anonymous said...

In my view minority shareholders have never had any say in the mgt or corp gov matters of a public co. Check it yourself when you had one. It doesnt mean that we should continue to accept; but practically it is never going to happen. That is called majority stakeholder mgt. you have effectively 2 choices: one, buy the share if you have faith in mgt and board for doing good things for the business and consequently for you; it means don't crib if your assessment is correct or not. Two, don't buy into where you have no faith; i.e. be where you are comfortable. There is no point criticizing and cribbing about things not under your control. Do what is under your control, i.e. buy, sell or hold.

QUALITY STOCKS UNDER FIVE DOLLARS said...

Maybe its about time for apple to do a stock split. Since google is getting into the act.

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manicuregirl said...

I don't see this as that bad, I think it has its advantages in a falling market place.