Corporate Governance – Caveat emptor pt. III

Another investor without a leg to stand on.

• Another investor has come out of the woodwork to criticise Alphabet’s expenses and its hiring practices but once again, this investor has no grounds whatsoever for complaints in my opinion.
• This time the company is Alphabet and the investor is TCI which holds $6bn of Alphabet shares and is criticising the high salaries paid to non-engineers as well as the 36,000 headcount growth just as revenue growth has fallen sharply.
• The problem here is that none of this is new.
• I have been calling out Google’s bloated general and administrative expense (GNA) line for over 7 years but as usual, while the share price continued to go up, no one cared.
• It is only when people start losing money, that any attention gets paid to these issues.
• To be completely fair to Alphabet, the GNA line now looks much better at 5.2% (Q3 2022) of turnover compared to the 7-8% it regularly used to be during the pre-pandemic years.
• The real issue here is actually R&D which has grown from 11.8% of sales in Q3 2021 to 14.9% of revenues in Q3 2022 which while it is an increase, R&D is the engine of future growth and at 15% of revenues does not look particularly bloated to me.
• Sales and marketing has also grown in the last 12 months to 10% of sales from 8.4% in Q2 2021 but again, this does not look particularly excessive.
• It looks to me like Alphabet was expecting better revenues than it managed to achieve, and as a result of that, investments became a higher percentage of revenues than planned.
• Google does pay high salaries and benefits to its staff, but productivity measured as revenue per employee is pretty good compared to many other companies which would seem to justify the high price Google is paying.
• TCI obviously wants Alphabet to scale back investments until digital advertising revenues recover but like Meta Platforms, Alphabet is controlled by its two founders Sergey Brin and Larry Page.
• The founders control 51% of the votes of the company despite owning less than 12% of the economic interest meaning that minority investors like TCI will absorb a proportionately large amount of pain relative to the say that it has in the management of the company.
• I have argued for years that this is bad practice and results in unfair treatment of minority investors.
• However, whether the practice in public companies is good or bad is immaterial because this issue has long been known by the market and competent investors should take this risk on board when considering what investments to make.
• When I look at a company, I take this into account by applying up to a 30% discount to the fair value of the shares depending on the degree to which smaller shareholders are being disadvantaged.
• Companies like Alphabet, Meta Platforms and Baidu get the full 30% discount.
• If the company is still attractive after that discount, then I am happy to own it knowing that I am being properly compensated for being unfairly treated.
• This is why investors have no grounds upon which to complain as they invested in the company in full knowledge of this issue and the risk that it carries.
• The watchword continues to be caveat emptor.