The GOOGL re-rating

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)