Tuesday, August 25, 2015

Chicka Chicka Boom Boom: The ABC’s of Google

Readers with children of a certain age know Chicka Chicka Boom Boom.  In fact, if you’ve read it once, you’ve probably read it a million times.  Even now, some 15 years after my final heartfelt performance, I can still recite the book (mostly) by heart.  

Chicka is designed to teach young children the alphabet.  The plot (spoiler alert!) is thus: The letter “a” challenges “b” and “c” to meet him “at the top of the coconut tree.”  That’s followed by a stampede of the other 23 letters racing up the tree.  Soon, as you might expect, they all come crashing down.  Consonants are bruised.  Vowels are maimed.  Many phonemes will never be the same.

On August 10 Google unexpectedly announced that it was reorganizing itself under an umbrella company called Alphabet.  Mind you, this was an act that involved moving boxes around on a piece of paper and assigning new names to old projects.  It wasn’t quite the invention of a time machine, or even a Romulan cloaking device. 

Though, given the stampede up the coconut tree, it might have been.

My initial thought was this: In the interest of being dazzling and unpredictable, Google had gone coconuts.  Here, they had this perfectly opaque organization with an obscenely profitable search and advertising business model funding all of these harebrained R&D projects.  Whatever they wanted to do, they did, no questions asked.  The zanier the idea, the more apt they were to be applauded for their daring-do.  Nobody but nobody could track the individual losses and cash consumption of each project except those with a need to know.  

And nothing, of course, stopped the leaders from arranging the internals of the organization any way they chose.  Put the driverless-car guys in a garage in Cabo.  Put the Google Glass crew in a garage in Telluride.  Who was the wiser?  You could even name each garage by, say, a letter if you were so inclined.  No breathtaking announcement required.  All the benefits of small, agile teams with all of the opaqueness of a Romulan War Bird. 

On August 9, before Alphabet, Google was one big, happy, profitable company with a world-class brand and almost no accountability to investors—just what every CEO dreams.  Consequently, to now visibly separate the wheat from the chaff and assign a letter to every cash-guzzling moonshot—well, perhaps Downtown Josh Brown tweeted it best:

In any event, what seemed clear is that this was an announcement with no new profits being generated, no big initiatives launched and no breakthroughs unveiled.  The idea behind Alphabet could have come from a napkin sketch 15 minutes beforehand.

Chicka chicka boom boom.  Will there be enough room?  That’s the question I set out to try and answer.  Here's some of what I read:

One of the experts over at CNBC called the move "brilliant" and "as creative as the company itself."  Why?  Because "Google's leaders have the wisdom to know that size and creativity are inversely correlated."  Consequently, the decision to break the company into a collection of "innovative organizations" will provide "their leaders the freedom to innovate without near-term financial constraints." 

Are you following?  By breaking out search profits from R&D losses, some of which are presumably staggering, the pressure on management will somehow be reduced.  Innovation will have room to blossom.  Right?  "The most significant aspect of Google's reinvention as Alphabet," the article adds, "lies in its capacity to recruit and retain amazing creative talent."  In other words, by becoming "Alphabet," Google can now attract great leaders.  Then the CNBC piece goes on to list all the great leaders Google already has in-house running its various businesses.  Without becoming Alphabet.

It's hard to make this stuff up.

Here's another fan, one who refers to the creation of Alphabet as "pure genius."  Why?  Because--in an article the author wrote a few months ago, he said--one of the principles of the future organization will be that it "operates like a small company."  Let's just leave that idea be for now (discounting Google, Apple and Amazon) and suggest that how something looks on paper, and how it operates in reality might be two entirely different things.  (I'd love to tell you more about this idea, but I'd have to click on the author's expository video, which is simply not going to happen.)

Then there are the folks who believe Google has done nothing more than become like Berkshire Hathaway.  This will make your teeth hurt.

In The True Mastermind of Google's Alphabet Warren Buffetthe author argues that Page and Brin will do what Buffet and Munger "are famous for: They'll allocate capital among Alphabet's businesses and determine how the CEO of each unit is paid."  This is something presumably they have not been able to do until now, and something they'll undoubtedly want to share each quarter with investors.  "It's not a stretch to imagine," the article adds, "Nest could one day be like Geico Insurance." 

Nest could be like Geico Insurance?

Where to start?  Each Berkshire Hathaway business is financially independent; virtually all of Google's businesses are dependent on search profits.  Capital allocation for profitable businesses competing in known markets against known competitors, and capital allocation for speculative moonshots in unformed markets are two entirely different processes.  Berkshire is good at buying money-making (often low-tech) businesses and making them better.  Google buys invention and tries to create innovation.  Berkshire is known as a frugal operator.  Google has been traditionally anything but.   

Despite the superficial comparison, is there anything in the underlying business models of these two companies that would indicate Alphabet has a prayer of looking like--or would want to look like-- Berkshire Hathaway?

I'm sitting here virtually drowning in online speculation about Alphabet.  Most of it seems knee jerk and misguided.  Here's what the company itself says:  As early as Q4 2015, management will be able to break out two reportable segments for investors, with Google separate from the other Alphabet businesses.  In other words, management will now parade quarterly before investors one company with a wildly profitable, quasi-monopolistic business model and another with a cash-killing, death-defying venture capital model.

I think investors win.  I know investors win.  But why?  They had zero leverage to get such a sweet deal on organizational and cash transparency--little more than haranguing management on quarterly earnings calls. 

And I don't see what Google wins.  Will it help their share price?   (We did see a surge right after the announcement, for sure.)  Even if it does, to what end?  Another public offering?  Because they need cash?  Can they do anything now that they could not do before, without intense scrutiny?  And, if management truly thought its stock was misunderstood and undervalued, why not buy some back with their cash hoard?  

It feels like Google has kowtowed to investors, maybe for the very first time.  As Time magazine wrote, "Over the past decade, technology investors have gotten significantly more comfortable bullying big companies, no matter how profitable, which they deem lacking focus."  Even untouchables like Apple and Microsoft have caved on board seats and stock buybacks from time to time.

The folks at MarketWatch have taken a dim view of the entire exercise.  "The only people who are guaranteed to profit from the shell game are the army of lawyers and accountants who will be employed to dot the i's and cross the t's in the reorganization," they've concluded.  They then quote one hedge manager as saying Google is merely providing the transparency that is "standard operating procedure for most other companies."  The CFO Journal has concluded there are "no obvious tax benefits emanating from this transaction," nor will the reorg do anything to improve future spin-off opportunities.

I admire Google, partly because they have resisted acting like most other companies.  However, overnight, the company went from "don't be evil" to telling investors it would be "cleaner, more accountable and more management scale."  It makes me sad to think that another of our premier technology players might have jumped onto the short-term-kow-tow-quarterly earnings treadmill.

The question is this: Is Alphabet truly bigger than Google?  

The answer is, at least if I understand the consensus in the market: Chicka chicka boom boom.