Splitting It UP

Edited by Vani Rao

A look at Google’s recent stock split decision

Google LogoGoogle Inc. (NASDAQ:GOOG) is finally ready to split its stock for the first time, more than three years after co-founders Larry Page and Sergey Brin began discussing a move engineered to ensure that they retain control of the most powerful internet company.

Stock Split Details

Prior to the internet bubble, stocks were routinely split to rousing gains. Companies did not want stocks to trade above $100, much lesser than $1,000, to allow more widespread ownership by small investors typically required to trade in 100-share lots.

After the bubble, the reverse appears to be occurring with the stock-split shoved into the list of stuff that was wrong with the internet bubble period. In addition, online trading platforms reduced the costs of trading and made the trading of odd lots below 100 shares much easier. Small investors priced out of $100 stocks that required a $10,000 investment in the past can now obtain smaller lots, thereby reducing the initial investment.

The changes kick off on April 2, 2014, when Google will pay dividends using the newly created Class C stock to existing holders of the company’s Class A and Class B shares. The new Class C shares will carry no voting rights, making them unusual relative to the common shares issued by most companies. In addition to Class A and Class C shares, there is a third class of shares, “Class B.” Page and Brin own Class B shares, which do not trade publicly.

When it comes to voting rights, each share of Class A stock carries one vote. Each share of the Class B stock (owned exclusively by Page and Brin) carries10 votes. Most importantly, Class C shares do not carry any voting rights, meaning that Page and Brin are preventing any further dilution of their power in the company. The company is expected to only issue shares of Class C moving forward. Currently, the two founders control 56% of Google’s voting power. They will maintain the majority control by only issuing stocks without voting power moving forward.

When the split occurs, Page and Brin will be given one additional share for every Class B share that they own, just like investors who own Class A shares. However, like everyone else obtaining Class C shares, the ones Page and Brin obtain will have no voting rights.

Google’s manoeuvre is expected to have at least one thing in common with other 2-for-1 stock splits. The share price will probably be halved from the current price of $1,134 beginning Thursday, April 3, 2014, in the first trading session following the split.

If there is a big spread between the trading prices of Class A and Class C shares during the first year of trading, Google will be required to pay an estimated $300 million to $7.5 billion in cash or additional stock to help make up the difference. Google agreed to those terms to settle a class-action settlement alleging that the stock split was set up to benefit Page and Brin at the expense of other shareholders.

S&P Dow Jones Indices has reversed course on the way that it will deal with the situation in the S&P 500. Originally, the index provider was going to replace Google’s Class A shares in the index with the Class C shares. However, late Tuesday, S&P Dow Jones Indices said that it would include both the Class A and Class C shares. This now means that the S&P 500 will have 501 stocks in its universe representing 500 companies.

Why Split

Page and Brin originally had little interest in going ahead with a stock split, even as Google shares soared from their IPO price of $85 in August 2004 to more than $700 in 2007. They reasoned a split would only cheapen the shares and attract speculators looking to make a quick buck. Page, 41, and Brin, 40, prefer long-term shareholders who are more likely to tolerate their strategy of making big bets on technology that may take years to pay off.

Yahoo Chart
Source Yahoo! Finance

However, the company’s workforce has increased manifold soared from about 2,300 employees in 2004. Moreover, the founders’ perspective evolved as Google continued to issue more stocks to fund acquisitions and compensate the employees at the end of last year.

The growth in Google’s outstanding shares threatened to undercut a system that Page and Brin had set up to ensure they will have a final say in all key decisions. Their control is based on their ownership of Google’s Class B stock, which entitles them to 10 votes for each vote of Class A stock.

This means that Page and Brin own almost all the Class B stock or 46.7 million shares, which gives them 56% of the company’s voting power. Nevertheless, they were worried that their voting power would eventually slip below 50% as they sold more of their Class B and Class A shares to finance acquisitions and reward other Google employees.

How Does a Split Solve this Problem

The addition of more than 330 million Class C shares provides Google with a new currency that will not undercut the power of the founders. Their control over the company should remain intact because Class C stockholders cannot vote against them. Although rare, Google’s reliance on non-voting stock to protect their founders’ interests is not unprecedented in the technology industry. Facebook Inc. (NASDAQ:FB), LinkedIn Corp. (NYSE:LNKD) and Yelp (NYSE:YELP) have all issued non-voting stock for the same reason as Google.

Many media firms, particularly family-run businesses, also have two types of stock. That’s the case for Rupert Murdoch’s News Corp. (NASDAQ:NWS) and (NASDAQ:NWSA) and Twenty-First Century Fox (NASDAQ:FOX) and (NASDAQ:FOXA).

Cable giant Comcast has three classes of shares like Google. Two are traded publicly (NASDAQ:CMCSA) and (NASDAQ:CMCSK). The shares with a symbol ending in A carry voting rights. The ones with the not-so-special K do not. Comcast’s Class B shares are held by CEO Brian Roberts, whose father, Ralph, founded Comcast.

Shareholders React

Google Logo 2Unsurprisingly, some shareholders were not too pleased with the proposal. The fact that it has taken this long for the split to come into effect is because some shareholders sued to prevent the company from going ahead with this move. Two shareholders, the Brockton Retirement Board and Philip Skidmore, were so upset that they filed a class-action lawsuit in Delaware seeking to block the split. The legal spat is the main reason it has taken so long for Google to execute a split that was announced nearly two years ago.

Google settled with that group last June. Google agreed to stricter board reviews of some acquisitions using company stock and also agreed to compensate shareholders if the new Class C shares begin to trade at a discount to the Class A shares with voting rights.

Who Will Profit from this Move

Stockholders do not just profit from the company’s success, but also have a say in how it is run. The notion that Google shareholders have any rights is a Woody Allen-esque travesty of a mockery of a sham of a mockery of a travesty of two mockeries of a sham. The company wants stockholders to blindly put their faith in Page, Brin, and Schmidt and hope for the best.

Still, is it not reckless for an investor to throw caution completely to the wind and trust that Page, Brin, and Schmidt will never make a mistake? The technology sector has many companies that were once leaders but failed to adapt to changing times. Hence, it would not be advisable for investors to drop Google — it is, after all, a phenomenal company. However, new investors should question the meritocracy of buying the new Class C shares. In fact, if I were an existing Google investor, I would sell the Class C shares I received in order to buy more Class A shares. That way, my vote would still count as much in the future.

It is all slightly odd that stock splits and consolidations should add value to firms. But the fact is that they do and that is something of an affront to theory. However, we must deal with the world as it is, not as theory predicts it should be.

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