The alphabet now has 81 letters.
Did that leave you scratching your head? The Alphabet we’re referring to is the name of Google’s new holding company.
A holding company? Just a fancy term for a company that owns other companies. Think Warren Buffet and Berkshire Hathaway. Google – our soon-to-be-evil-overlords – is now just one company of many within Alphabet.
The restructuring is aimed at alleviating pressure on Google. The founders, Sergey Brin and Larry Page, often took flak from investors for the non-profitability of some of their more….eccentric ventures. Self-driving cars and a giant stratospheric network of balloons providing internet to the world are just some of the “moonshot” projects that will be divested from Google as the original business becomes more streamlined.
If you think about it, it’s kind of brilliant. Google has a number of ambitious ventures which are often judged by the rules by which investors judge Google (a mature company). If the division responsible for driverless cars records a big loss for the quarter, it’s lumped in and rolled into the overall performance of Google. No bueno for shareholders and investors.
The Berkshire Hathaway…Way
Think back to Berkshire Hathaway. It is a holding company for such diverse businesses such as railroads, insurance and running shoes. It’s averaged annual returns of nearly 22% over the last five decades.
That’s entirely nuts, but the reason Berkshire Hathaway has functioned so well is two-fold.
The first reason: Buffet leaves his management alone. He knows the value of having good managers and the companies he acquires have excellent people running them. Once he brings them into the fold he just lets them do their thing. Buffet doesn’t dip his fingers into the honey-pot.
The second reason: Berkshire Hathaway gets a steady stream of income from its insurance business. They take this money and use it to finance all the deals and leveraged buyouts that have made the company a behemoth of the investing world. It’s the economic moat that surrounds Berkshire’s business castle.
The term economic moat was actually popularized by Buffet himself. A moat, or body of water, protects a king’s castle from enemy invaders. Similarly, an economic moat refers to the specific competitive advantage a business has that allows it to keep other companies from taking their market share and profits.
Google is Not a Conventional Company
Larry Page and Sergey Brin are taking a page right out of Buffet’s playbook. Under the new structure, Sundar Pichai will take over as CEO of Google. Nest Labs, a producer of smart-gadgets (thermostats, smoke alarms) for the home of the future, will be led by Tony Fadell – a former Apple executive. Calico, the biotech company established with the goal of combating aging will be headed up by Art Levinson.
Let the best people do their best work.
Each is a separate business on its own merit, allowed to sink or swim, no longer clutching to the kickboard that is Google as they thrash about in a pool of non-profitability. This means the new CEO of Google, Sundar Pichai, will be able to focus on Google’s core functions…namely SEARCH and others like Android and Youtube.
Page and Brin, on the other hand, can focus on creating artificial intelligence, visual reality goggles, robot seeing-eye dogs, drone daycare, etc.
Just as Berkshire Hathaway’s business is financed by the insurance engine, Alphabet’s more fanciful ventures are financed by Google’s search engine. Search is the basis of almost every other Google venture. Android, Chrome, Gmail: these are all free products, subsidized and paid for by profits from, yep, search. Nearly $20 billion in profits to be exact, 90% of which is generated by advertising revenue.
So what are some of the offshoots of Google that will now be semi-autonomous entities?
We mentioned Nest and Calico…but that’s just the tip of the Alphabet iceberg. There’s venture capital firm Google Ventures; an equity investment fund called Google Capital; Google X: the semi-secret facility dedicated to making Google moonshots come to life; and even a company that works on glucose-sensing contact lens (Life Sciences).
There you have it. Alphabet Inc. will replace Google as the public company and all shares of Google will be converted into Alphabet stock. It will still trade on the NASDAQ as GOOGL and GOOG though. As if to tell you who’s really in charge.
It’s the Right Time
The restructuring comes at the right time and reflects the new cost-conscious approach of the CFO, Ruth Porat. Google faces threats on multiple fronts and the ability to be lean and free of dead weight could make the difference in the upcoming battles. The company has rivals in mobile and search. Not to mention companies like Facebook, who are luring advertisers away on the promise that they’re closer to the user and have better insights/data.
Investors seem to be happy. Google’s stock price has risen on the announcement of Alphabet’s creation. In the five trading days soon after the share price was up as much as 6.5%. Investors will now be able to see the financial performances of all the different elements of Alphabet, which makes for greater transparency and understanding. They will also be able to look at the main arm of the business, Google, on its own.
Google is more than just a web-search company right now, and this new move reflects the change. Expect Google to thrive and build up its other ventures into profitable elements in their own right, turning them into dangerous alligators that patrol their economic moat.
To learn more, head over to Wall Street Survivor!