Google – The birds and the elephant.

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Many birds hit with one stone but the elephant is missed.

• Google’s restructuring should bring some improved visibility and flexibility into Google (the birds) but the corporate governance problem (the elephant) looks certain to remain.
• Google has announced that it is to reorganise into a holding company called Alphabet within which the assets that make up Google today will be held.
• In effect the new areas in which Google is investing like driverless cars, smart home, Life Sciences and so on will be stripped out of Google and held as separate entities.
• Google will then report on these as separate units of which the core Google business will be one.
• This should begin with the Q4 15E earnings report.
• This will provide investors with better visibility in terms of the performance of the core business and how those profits are being invested for the long term.
• It will also provide the following operating advantages.
  • The new areas of investment will be companies in their own right and will be much more independent and have greater speed and flexibility.
  • I think that this will also allow them to raise money and make acquisitions independently using their shares as currency.
  • It will also make it easier to retain talent as hires into these companies will be able to have options based on the equity of the specific company rather than Google.
• However, how this would work should one of these outside ventures become so successful that it needs to become part of the core business is uncertain.
• Google would have to buy out other shareholders which could end up being much more expensive for shareholders.
• Sundar Pirchai will become CEO of the Google subsidiary while Sergey Brin and Larry Page will be President and CEO of the holding company, Alphabet.
• The Google share structure will not change and Alphabet Inc. will trade under the same tickers as Google does today.
• With no restructuring of the share distributions there will be no improvement in the shortcomings in corporate governance.
• Google and the other subsidiary companies will be controlled by Alphabet which in turn will continue to be controlled by the founders.
• I think that this shortcoming will mean that when things go wrong, the depth and duration of the problems will last much longer than they otherwise would if shareholders had the power to intervene.
• I continue to believe that this warrants a 30% discount to any valuation placed upon the shares of Alphabet.
• When I apply this discount I arrive at a fair value of $637 which is now 5% below where the shares were trading after hours trading.
• Consequently, without a complete restructuring of share distributions to one share one vote, I do not see further upside.
• I have been a big advocate for Google for the last 2 years but I think the time has come to think about putting at least some of the money elsewhere.
• Microsoft is one potential place to look.