Wednesday, September 9, 2015

What's in a name? Of Umlauts, The Alphabet and World Peace!

As the title should forewarn you, this is a post that will meander from eating spots to basketball players to corporate name changes. So, if you get lost easily, you may want skip reading it. It is triggered by two events that occurred this summer. One is Google's widely publicized decision to rename itself Alphabet and to reorganize itself as a holding company. The other is the much less public news that the eating place across the street from the building where I teach will be reopening with a new name "Bröd Kitchen", a new menu, and (probably) higher prices.

Coffee Shop to Eatery to Bröd Kitchen

In my post on my valuation class, I noted that this is my 30th year at New York University and I have seen the neighborhood around the school transition over time. When I started in 1986, I had my office and did the bulk of my teaching in the graduate school campus, which was downtown, but I lived near and still taught some classes at the undergraduate school. Right across the school was the Campus Coffee Shop (Yes! This is exactly what it looked like!) and it was exactly what its name suggested, an unpretentious coffee shop. The menu was primarily breakfast food, served all through the day, and the coffee came in one flavor (bitter), one texture (sludge) with only two add-ons (cream & sugar). The waiters and waitresses were all crotchety and old, viewed service as a foreign concept and I can only pity the poor person who tried to order a cappuccino or latte. To compensate, the coffee was only 50 cents, the egg sandwich about a dollar and you got what you paid for.



About 15 years into my stint at Stern, the building's landlord (a brutally oppressive tyrant named New York University) decided that the campus coffee shop was too downscale and it was replaced by the Campus Eatery. This place offered fewer seats, a wider menu with paninis replacing sandwiches (as if putting a bad sandwich in a hot press can make it a  good one) and machine-made cappuccinos that had neither milk nor espresso in them. Not surprisingly, the prices went up to reflect the name change from coffee shop to eatery, though the only edible items on the menu remained the breakfast items, albeit at twice the price you paid at the coffee shop.



At the start of this summer, I noticed that the Campus Eatery had closed and that the space was being renovated for a new restaurant. The restaurant has not opened yet (at least as of last Thursday, which was the last day I was in the city) but the name went up a few weeks ago and when I saw that it was Bröd, the umlaut made me suspicious. My trusted Google search engine found another eating place with the same name in New York, and I was able to find the company's website. It looks like a bakery with a Scandinavian tilt and Northern European prices, but the only consolation price is that it could have been worse. This could have become a Le Pain Quotidien, a New York based food chain with a pretentious French name and prices to match. (A reader points out to me that it is in Brussels, but according to the company's website, it is a New York based company with branches all over the world!)
Update: I did a trial run this morning, since Bröd opened. Bought an iced coffee and a Cherry Danish (in keeping with the Scandinavian theme). Cost me $9.53 and it tasted just like the iced coffee and Danish that I get from the street cart that I usually go to.. and pay $2.50 for.. So, lesson learned!

While these are three different businesses, with three different owners, they have all occupied the same space and I tend to think of them as the same eating place with three different names. That started me ruminating about why people and businesses change names and whether those name changes can affect the values that you attach to the entities involved. 

Reasons for Name Changes
I must confess that I have changed my name, though the change was more the result of happenstance than design. I grew up in South India in a period where caste names had been abandoned, but family names were not in vogue yet, and went through much of my school and college years known only by my first name (Aswath) and without a last name. It was as I was filling out my I-94 form on the my flight into the United States that I faced the question of what to use as my family name, and I used my father's first name, Damodaran, as the filler. Since then, I have seen friends and acquaintances change their names, mostly as a result of marriages, and businesses change names, with mergers being the most common trigger. However, there are other, more interesting reasons for name changes, though, and here are a few of them:
  1. To decontaminate or escape: In some cases, a name may get contaminated to the point that changing it is the only way to escape the taint. When Philip Morris changed its name to Altria in 2001, it was partly an attempt to remove the taint of tobacco (and its associated lawsuits) from its then food and beverage subsidiaries (Kraft and Miller Brewing). While there may have been other reasons for Tyco Electronics to rename itself TE Connectivity in 2010, one reason may have been to disassociate itself from the accounting scandals at its parent company
  2. To change: Changing your name can sometime make it easier for you to change yourself, as a person or how you operate, as a business. In this context, corporate name changes can cover the spectrum. Some  name changes reflect changes that have already happened, as was the case when Apple Computer became Apple in 2007, a concession to the reality that it was deriving more of its revenues and profits from its smartphones, tablets and retail than from its computer business. It can sometimes be a precursor of changes to come, as was the hope at International Harvester, when it sold off its agricultural division to Tenneco, renamed itself Navistar in 1986, and worked to make a name for itself in the diesel engine and truck chassis markets.  Finally, there is an escapist component to the some name change, where the firm is trying to  get away from troubles and hopes that changing its name will help it in the endeavor. When Research in Motion changed its name to Blackberry in 2013, it was in an attempt to divert attention from declining sales and a business in trouble. 
  3. To market: To make money, you have to sell your products and services, and not surprisingly, companies are drawn to names that they perceive will make it easier for them to market. In some cases, this may require simplifying your name to make it easier for customers to relate to; Tokyo Tsushin Kogyo did the right thing in 1958, when it renamed itself Sony. In still others, it may be designed to have a name that better fits your product or service; we should all be thankful that Larry Page and Sergey Brin changed their search engine's name from Backrub to Google a year into development. Finally, the name change may be to something more exotic, in the  hope that this will give you pricing power; the only surprising thing about L’Oréal renaming of its US subsidiary, Cosmair,  to L’Oréal USA was that it took so long to happen. After all, it must be a marketing maxim that having an accent in your name (the é in L’Oréal), in an Anglo-Saxon setting and that adding a apostrophe can only add to your cachet.
  4. To fool: In one of the more publicized frauds of the last century, a German named Christian Gerhartsreiter managed to fool East Court elite (both society and business) into thinking that he was Clark Rockefeller, using the last name to open doors to country clubs and financial opportunities. Corporations have played their own version of this game, incorporating the hot businesses of the moment to their names, whether it be dot.com in the 1990s, oil in the last decade or social media today. 
There are two points to note. The first is that these reasons are not mutually exclusive and more than one may apply for a given name change. The other is that the lines of separation between the reasons can also be fuzzy, with the one separating marketing and fooling investors being perhaps the most difficult one to delineate.
Valuing and Pricing Name Changes
Can changing your name change your value as a business or you as an individual? You may scoff, but I do believe that there are pathways to changing behavior or increasing value that begin with a name change. You will not find them if the name change is purely cosmetic or if your reason is to fool customers or investors, but you may, with any of the other reasons. Thus, if your rationale for the name change is to remove the taint of an old name or to market your product more easily,  it should show up as higher revenues and profits, if you are right. If the name change is the first step in changing the way you run as a business, it should be manifested in your investing, financing and dividend decisions, and consequently in value. The proof, though, is in the results and it is true that the benefits are either transient or illusory in many cases.

It is much easier to see a price effect from a name change, and especially so, if your end game is fooling investors. The highest profile studies of this phenomenon have centered around the dot com era, when the renaming was visible for all to see (adding a .com to an existing name or removing it), and the evidence was striking. The first study looked at companies that added dot.com to their names in the late 1990s and found that stock prices surged by astonishingly large amounts on the news, often with no accompanying change in operating focus or business practices. The second study looked at companies that removed dot.com from their names after the dot.com bust in 2000 and 2001 and uncovered an equally unsetting market reaction, i.e., that stock prices surged on the removal, again with no really accompanying shift in fundamentals. The results from both studies are graphed below:


To back up the proposition that this is not just a phenomenon in technology stocks are unique to that time period in market history, a study looked at US and Canadian companies that added "oil" or "petroleum" to their names between 2000 and 2007, a period when oil prices are booming, and found that stock prices reacted positively to the addition, with US investors greeting the name change more effusively than Canadian investors. If history is any guide, these companies will now gain by removing "oil" from their names today, with oil prices at historic lows.

What are the lessons from these studies? The first is that names do matter in markets and that companies sometimes choose names to please markets. The perils, as you can see even from the limited evidence that I have presented, is that investors are fickle and can change their minds and that a name that is value additive today can become value destructive in a while. 

Google's Alphabet Soup
A few weeks ago, Google shook up markets with its announcement that it was revamping the structure of the company, creating a holding company (Alphabet), with the core products of Google including Search, Ads, Maps, Apps, Android and YouTube, in one subsidiary (Google) and its experimental ventures in new businesses in other subsidiaries (though we will have to wait on the specifics). The immediate market reaction was positive, but as we noted in the last section, that effect can fade quickly. The longer term questions are two fold. Why did Google change its corporate name? Will the name change work?

On the first question, it is my view that three of the reasons listed earlier can be ruled out almost immediately. Given how successful Google has been as a company, in terms of generating earnings and value for its investors, it is implausible that the company would want to disassociate itself from on of the most recognized brand names in the world. From a marketing perspective, it seems inconceivable to me that it will be easier to sell an "Alphabet" product than a "Google" product, and I don't think that there are very many investors out there who see lots of money making potential in the alphabet. Thus, the only motive that we are left with is that the name change is designed to  change the way the company operates. 

If change is the rationale, the timing seems odd, given that Google just reported exceptional results in its last earnings report, triggering a 16% increase in market capitalization on the news. It is true, though, that Google is still a single-business company, deriving almost all of their revenues from advertising, and that all of its attempts to diversify its business mix have generated more publicity than profits. It is possible that the renaming and reorganization are designed to fix this problem, but will it work? I am skeptical, partly because there is talk that Page and Brin were using Berkshire Hathaway as a model, which makes no sense to me, since the two organizations have very little in common (other than large market capitalization). As I see it, Berkshire Hathway is a closed-end mutual fund, funded with insurance capital, and run by the best stock picker(s) in history, and its holding structure is consistent with that description, where Buffet and Munger have historically picked up under valued, well managed companies as investments, and left the managers in these companies alone. Google, in contrast, is composed of one monstrously successful online advertising business (composed of Google search, YouTube and add ons) and several start-ups that so far have been more adept at spending money than generating earnings.

If this name change is designed to alter that reality, it has to attack what I see as Google's two big problems. The first is what I term the Sugar Daddy Syndrome, where the earnings power and cash flow generating capacity of Google's advertising business has made its start ups too sloppy in their investments, secure in the knowledge that they have access to an endless source of additional capital.  (Update: Those who are more knowledgeable about Google's ways have pointed out to me that it is quick to lop of projects that don't work, which then makes its new product failures an even bigger mystery. Perhaps, this is a case of a Sugar Daddy with Attention Deficit Disorder!) The second is that Google, for better or worse, has been run as a Benevolent Dictatorship, with Larry Page and Sergey Brin calling the shots at every turn. The fact that Sundar Pichai, the new CEO of the Google portion of the Alphabet, is little known can be viewed as a sign of his modesty and self-effacing nature, but it is also a reflection of the outsized profiles that Page and Brin have had at Google.  So, for this name change to work, it has to solve both problems, and here are the signs that will indicate that it is working. First, I would like to see Google refuse to invest in one or more of its start-ups, on the grounds of non-performance and invest in or acquire a competing start-up in the same business.   Alphabet's new ventures become more like good start-ups, lean, mean and looking for pathways to make money, and Google Advertising behave more like a seasoned VC, looking for the best place to invest its money, inside or outside the company. (For those in the tech business who schooled me on Google's ways, thank you! I have much to learn!) Second, I would also like to see Mr. Pichai deny capital to a project that is prized by Page and Brin, and have them not over rule that decision. Given the history of Google's founders, the likelihood of these events happening is low, but I give Google better odds than I did Ron Artest, an NBA player with anger management issues, when he changed his name to Metta World Peace in 2011.

What's in a name?
If value is driven by substance (cash flows, growth and risk), it seems absurd that name changes can affect your value, but I have learned not to dismiss them as non-events. Name changes can lead to shifts in investment, financing and dividend policy that can affect value, but more important, they can have substantial price effects. That may seem irrational, but it is ironic that academics in finance would be so quick to make the judgment that what you name something cannot alter its value or significance. After all, these same academics have learned that attaching letters from the Greek alphabet to their measures of risk (beta) or performance (alpha) provide these measures with a power that they would never possess otherwise. So, who knows? These name changes may all work: Bröd Kitchen might deliver delicious and cheap food, Page and Brin may actually be willing to give up control at Google and Ron Artest could become a Buddhist monk!

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8 comments:

Adam said...

Professor, I have one suggestion not mentioned or more accurately a variation of your reorganization idea. Ireland has passed laws, which are intended to phase out the "Double Irish" tax plan that Google has used for years to reduce taxes. While a reorganization for tax purposes alone would probably be stopped by the IRS, a reorganization that allows for tax advantages might be allowed. These tax payments affect cash flows, which impacts valuations. If people believe that Google will continue to have low tax rates when previously they saw them coming to an end, then an increase in stock price is completely rational after the name change. The impact of these changes is dependent on your tax assumptions, but there is an alternative narrative to this name change impacting valuations.

Anonymous said...

Dear Prof - Thanks for memorializing this landmark. I am a 1997 MBA and your student. This article brought back a lot of fine memories. I say fine because it reminded me how I always avoided going into the old time-warped coffee shop eye-sore and instead got my breakfast at that wonderful tiny muffin place on 4th street next to Stern (can't quite recall its name now but the muffins were loaded with butter and sweet as can be.)

Joe Cabrera said...

I recently covered Google's business structure change and the potential changes it will have on the company's financial reporting.

https://www.linkedin.com/pulse/new-google-mantra-dont-transparent-joe-cabrera

I see it largely as a move to hide their numbers under a consolidated balance sheet.

Rob said...

Bröd means Bread in Swedish :)

Thanks for a great blog!

Sia said...

I think you severely overestimate the control Larry and Sergey assert over decision of Google. Alphabet now has a CEO of Google and a CEO of Youtube.

XFL said...

Dear Professor - This question is entirely unrelated to the current post.

After having worked as an analyst on the buy and sell side, I have never understood why analysts focus on margins so much? I mean, and please correct me if I am wrong, margins of a business only tell one-half of the story.

Shouldn't we always look at ROIC instead which then captures both sides of the equation? So for example, if a company's margins are cut in half over time (perhaps due to a profound change in its business mix) but its balance sheet during the same period is cut by 90% (an extreme case simply to illustrate my point..), wouldn't that company be far more valuable to a prospective investor than one that had maintained or grown its margins but by disproportionately inflating its balance sheet? I hope I am articulating this well enough.

Anyway, I hope that you might address this issue in the future (or if you have already, please let me know where? I think it's a very important one.

Thanks!

Brett Nocerini said...

I wonder if alphabet is met to help with compensation. Maybe kids keep bailing out of Google for startups with big growth potential. Now alphabet can more easily issue stock in a subsidiary to employees and promise to spin out the division on a few years to give them liquidity. Employees maybe own 20% and alphabet owners have 80%. Employees get huge upside when they start instead or boring old Google stock that they can't move the needle on. Alphabet looks like a Loews with majority stakes in lots of public businesses.

Abhay Vig said...

Google did operate through its google ventures arm where it invests in scallable tech startups through which it expects grow its revenue stream or exit , what i find interesting is the number of such startups where google has been successful to get a DEAL , although one can say google has been picky.
The reason being a simple one "if i am a tech startup , why should i take google venture's investment when i know they can learn quickly and make me redundant ." Am sure there are contracts which could safe guard.
But a spin off GV and a new name as a separate entity , with rationed money to invest in google's own or competing startups could create an environment of competition and remove slacks if that's the case within google and also would make it easier to compete with other VCs looking for good DEALS.