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....)