MorningWord 8/11/15: $GOOGL Elemeno pee

by Dan August 11, 2015 8:52 am • Commentary

Shares of Google are up 6% in the pre-market on news that they are changing their corporate structure, with an eye towards greater transparency and accountability for emerging businesses.  You can reader far smarter peeps than I on the merits of such a change, but I am hard-pressed to think that at some point in the not so distant future investors will look back and say “remember when the Google guys did that stupid Alphabet thing?”.  I know, I know, they are geniuses and this does seem like a big concept to become kings of Silicon Valley. But Google is Search and Advertising at its core and that’s what’s financed all the attempts at side projects over the years. Some of those side projects have worked out, like Chrome and Android. Others like Google+ and Google Glass, not so much. And that’s not even mentioning hundreds of the crazier side projects that are often hard to distinguish from their April Fool’s fake ones.

If this sort of structure change came during a bear market I suspect the initial reaction from investors would be to send the shares down 6% while questioning if this new structure is protecting the Google core from all those crazy side projects or now emphasizing them.

But you do have to give the Sergey and Cousin Larry some credit. After a very long period of under-performance vs many peers and the broad market, the hiring of new CFO Ruth Porat (from a Wall Street investment bank) was just the spark needed to rekindle investors’ love affair with the stock. If you include this morning’s gains, it’s up 27% since she joined on May 26, 2015:

GOOGL since May 1st from Bloomberg
GOOGL since May 1st from Bloomberg

So what from here? GOOGL has $74 billion in cash, $69 billion net of debt, so about 15% of their now $470 billion market cap.  In the open letter describing the corporate change, Larry Page highlighted the fact that he and Sergey will “rigorously handle capital allocation and work to make sure each business is executing well”.  Does that also mean the company will allocate cash to shareholders in the form of buybacks and dividends?  If they were to do so now (at least in the form of buybacks after the gap higher) they would go down in the record books as some of the worst stock traders ever.

Which brings me to a great piece from Barron’s from late June, How Much Do Silicon Valley Firms Really Earn?, which focused a great deal on Ms. Porat’s pay package:

a $71 million signing package, including $65 million in restricted stock that will vest over the next four years. In 2016, she will receive a base salary of $650,000 and restricted stock of $20 million, based on the compensation letter that Google made public.

How Google chooses to compensate their employees is their own business. But how they account for said pay packages should be their shareholder’s business. Google’s existing share class set up gives far fewer voting rights to individuals, making a lot of things none of your business, unless you are Larry and Sergey.

Barron’s posited:

Why the increasing use of stock compensation? Google hasn’t responded to our request for comment. The rising use of stock comp should make Google’s non-GAAP financial results look more favorable at a time when its stock has lagged the tech sector.

Google’s stock compensation reflects what some investors view as undisciplined financial management. Google’s research-and-development expenditures totaled $9.8 billion in 2014, 38% above the level in the prior year, and they range far from its core search-advertising business, to driverless cars and balloon-based Internet services in the Southern Hemisphere. Capital expenditures also are elevated, at $11 billion in 2014. Despite its strong earnings power and net cash of $62 billion, Google refuses to pay a dividend or buy back shares.

In 2015, consensus is calling for GOOGL to earn nearly $29 in eps, which when adjusted in GAAP terms works out to a little more than $23 a share. A lot of goofy things appear to be going on at Google, and not just their investments in the not-yet-so-lucrative Southern Hemisphere balloon internet business.

If I were a shareholder, I would be really happy with the stock back near all time highs. But I would wonder if the news flow is as good as it gets for the time being and possibly consider taking some profits.

The stock trades at 24x adjusted 2015 expected eps, and 21x expected 2016. Consensus estimates expect about 14% earnings growth this year and next, which could obviously be goosed through share buybacks (which has been one of my bullish arguments in GOOGL lately). But starting those buybacks at all time highs, would be, well… a bit goofy. Even for these guys.

So in sum, the street is definitely going to give them the benefit of the doubt, and frankly with the pre-market gains it appears investors have initially given a stamp of approval. I am sure that management has no shortage of great reasons for the reorg, I just wonder if all of those reasons are investors best interest. You can’t blame them for trying to make the most optimal business structure for them and their future plans, but maybe just maybe investors should be a tad more discerning.