Originally published at HBR.org.
Coverage of Google’s restructuring has focused
on the idea of Alphabet as a new kind of internet-era conglomerate. Optimists
compare the new entity to Warren Buffett’s Berkshire Hathaway; skeptics
point out that the conglomerate model seldom works.
But there’s a better comparison than
Buffett: it’s John Malone, the “mastermind” who
built the cable TV powerhouse Liberty Media. Malone is a brilliant financial
engineer, who creates separate capital structures — each with a
unique stock — for his different lines of business. Liberty Media, Malone’s
holding company, owns a portion of the stock in each business. This approach
allows Malone to attract equity and debt investors whose preferences regarding
risk and payoff horizon match those of the business in question.
Having separate stocks also allows Malone to
place bets when he believes that one line of business is not
correctly valued by investors. If he thinks one of Liberty’s companies has
a rich valuation, he can sell more stock to outside investors at a
high price. Or, if investors are enthusiastic about a new business that
Liberty is incubating inside one of its existing companies, he can spin out
that business as a “newco” with its own stock. Conversely, if Malone thinks
that the market has undervalued one of the companies, Liberty can buy back
its shares.
As The New York Times
put it in 1997, when describing the spinoff of TCI Ventures,
which provided innovative new broadband internet services:
For Mr. Malone, the spinoff is a way to get
more value from assets that he believes have been neglected by investors and
overshadowed by Tele-Communications’ prime business, the ownership of
cable systems with 14 million customers.
In this case, Malone traded investors some of
his shares in the core cable business for a bigger equity stake in risky new
ventures, which he thought the investors didn’t fully appreciate. Sound
familiar?
To be clear, Google has thus far given no
indication that it plans to create separate stocks. But its new structure would
making doing so much easier. As Todd Zenger
wrote here earlier this week, many investors want to buy stock in a
safer, maturing search advertising business without buying into Google’s
riskier moonshots. Alphabet promises to make the financial performance of its
companies more transparent, but the big change would be if some of these
companies traded under different stocks.
At that point Alphabet could sell shares of
Google to more risk-averse investors; it could raise capital for its
self-driving cars from the same sort of people who are betting on Uber or
Tesla; it could seek funding for its renewable electricity projects from energy
financiers.
A potential downside to this strategy is that
it would make it more difficult for the ad business to directly cross-subsidize
riskier tech investments. Formal contracts would be required for
transactions between the companies, and each side would need to be able to make
the case that a transaction was in the best interests of its respective
shareholders.
And there’s still the question of why a
holding company with full or partial stakes in a diverse set of somewhat
unrelated businesses can be expected to create value. We know from years
of academic research that on average, diversification into unrelated businesses
doesn’t create value for shareholders. Why should Alphabet be different?
But Google’s founders seem more than happy to
challenge the conventional wisdom. “Google is not a conventional company,”
they wrote in
their original founders’ letter. “We do not intend to become one.” Google’s
founders have strong views about where technology is going, and where it should
go, and they don’t seem that bothered if others disagree. Malone — also a
technology visionary — feels similarly; he’ll bet against the market when
he thinks that it is wrong. That’s something he has in common with Larry
and Sergey.
