Achieving a
share price re-rating is never easy. There are always goods reasons why a
listed company is undervalued. It can be due to poor financial performance, but
it generally goes beyond this and often results from investors’ mistrust in the
company and a low reputation on the stock market (Stock Reputation®). A good
reputation will be positively valued in the share price, because it lowers
investment risk and provides investors with confidence in the future behavior
of a company and its share price. On the contrary, a bad reputation with
investors will lead to a valuation discount.
In many
cases, achieving a share price re-rating requires a company to rebuild its
Stock Reputation®. It can take time, but in all cases it requires
self-questioning, moving the company’s priority back to shareholders and major
change - major change and real strategic transformation that companies and
management are not always willing to make when it affects the status quo.
To get a
re-rating, Google has decided to disturb its status quo – a remarkable thing
for a company of such size and stature.
Google is
one of the most successful corporations in the world, but it has not always
been a strong investment for its shareholders. From the end of 2014 to July
2015, Google’s share price remained almost unchanged. Over the same period,
Microsoft gained 20% and Apple 60%. This underperformance was largely explained
by the faster increase in costs compared to revenues (see graph). It was also
due to some unfriendly shareholder decisions such as the issuance of non-voting
shares and the sentiment that shareholder value was not the company’s real
focus. Investors questioned Google’s investment discipline. They doubted its
“moonshot” projects such as Google Glass and driverless cars. They were unhappy
with its disclosure that prevented them from following the performance of
Google’s different business lines with accuracy.
Google
revenue and cost growth (base 100)
On July 17,
Google’s stock price surged by 16.3% and since then it has outperformed
Microsoft and Apple by 5% and 15% respectively. To achieve this spectacular
re-rating, the company changed CFO, reduced its costs, but first and foremost
it created a new company: Alphabet.
For the
common person, Alphabet was just a new name for Google but for investors it
meant much more. It signaled the company’s focus on shareholder value again.
Alphabet is a collection of letters, but it also means alpha-bet (Alpha being
the investment return above benchmark). More importantly, it is a holding
company separating Google’s profitable and core internet operations (search,
YouTube, Android, etc.) from its various other “moonshot” businesses. Not only
will Alphabet allow to clarify cash allocation and investment strategy, but it
will facilitate the valuation of the company. Assuming that the value of its
long term projects is positive (despite losses) and the core businesses can
finally be fairly valued, Alphabet is likely to look undervalued on a
sum-of-parts basis.
Skeptics
will argue that this reorganization has not changed anything to the underlying
profit drivers of the company and that the new shareholder value focus remains
to be seen in concrete terms. They are right, but the stock market is looking
ahead and investors believe in promises when they come from trusted companies.
GOOGL
share price (USD)
