Investor Beware When Buying Google, Swift Transportation And Other 'Dual Class' Companies

By Benzinga | May 05, 2014 AAA

Public companies are generally not controlled by few shareholders; however, as more companies adopt "dual class" structures the numbers will continue to rise.

In dual class companies, economic rights are separated from voting rights, and voting control is concentrated in the hands of a few by giving select people a class of shares that carry more than one vote each.

For example, the April 15 IPO of Moelis & Co. (NYSE: Alibaba rejected its local stock exchange in Hong Kong for the NYSE because Hong Kong won't list companies with dual class structures.

Jon Lukomnik, Executive Director of the IRRC Institute told Benzinga that, "For someone investing in a dual class company, they are anchored at the hip with the major shareholder. You had better be sure they are a benevolent dictator and that he or she will share the economic benefits of the company."

As a practical matter, Lukomnik advised that before buying, investors needed to take an "extra step; not only research the company but also the dominant shareholder."

See Also: Senate: Unqualified DHS Watchdog Improperly Catered To DHS Bigwigs

Lukomnik knows whereof he speaks.

In October 2012 IRRC and ISS published a study of "controlled" companies and their performance. The report found that dual class companies performed worse over 3-, 5- and 10-year horizons than uncontrolled single class, one share-one vote companies and worse than single class companies with a controlling shareholder--someone who had placed enough capital at risk to amass 30 percent or more of the outstanding shares. Dual class companies also had more related-party transactions and other problematic corporate governance features.

This 2007 academic study also found that dual class structures hurt share price.

The problem with dual class structures is the separation of economic and voting rights; the controlling shareholder(s) can enrich themselves through their control of the company even if their control depresses the stock price. This kind of self-dealing is happening at Swift Transportation (NYSE: SWFT), according to the Teamsters Union, which is a long-term shareholder of Swift. Swift CEO Jerry Moyes is a minority shareholder, but controls the company because his Class B shares come with two votes each compared to Class A's one.

In a November 2013 letter to the company's chairman, Ken Hall, the Teamsters' General Secretary-Treasurer, detailed the union's concerns with Moyes' management of Swift: "excessive pledging of stock by CEO Moyes" and "hundreds of millions of dollars in related-party transactions with Moyes-controlled businesses."

Hall concludes, "…the problem at Swift is its dual class stock structure, which gives disproportionate voting power and control to a single holder of a minority of the outstanding shares.”

[Excessive pledging of stock can lead to the forced sale of a large number of shares and hurt stock price, which has happened to Green Mountain Coffee and several others]

Google (NASDAQ: GOOG) (NASDAQ: GOOGL) shows both the trend to concentrate voting power without requiring the controlling shareholders to risk a commensurate amount of capital, and the common stockholders' inability to do anything about it. Google used two classes of stock at its IPO; Class A, sold to the public, which came with one vote per share, and Class B, held by insiders like founders Sergey Brin and Larry Page, and Chairman Eric Schmidt, which comes with 10 votes.

See Also: Google Stock Split Should Have Icahn Fuming

That structure frustrated Google's Class A stockholders enough that about 80 percent voted to switch to a one share-one vote approach at the 2013 annual meeting. But instead of taking the hint, Google doubled down on concentrating power away from the public shareholders. Google issued Class C shares that come with no votes at all.

Google shareholders will get a chance to weigh in on this issue again at Google's 2014 annual meeting on May 14. However, given the voting structure, there is little chance the shareholder proposal to recapitalize with one vote per share will succeed.

Facebook (NASDAQ: FB) and several other tech companies use this approach. As the New York Times noted, Mark Zuckerberg will control Facebook even if he only owns 10 percent of its shares.

Beyond the effect on share price, the Times explained another risk is control inheritance: "had Apple gone public with Facebook's structure, Steven P. Jobs's widow, Laurene Powell Jobs, and Apple's co-founder Steve Wozniak (most recently a Dancing With The Stars contestant) would possibly still be in control."

comments powered by Disqus
Related Analysis
  1. Private Student Loan Debt: Overlooked 411
    Stock Analysis

    Private Student Loan Debt: Overlooked 411

  2. Q3: Not Amazing Nor Disappointing - Ahead of Wall Street
    Stock Analysis

    Q3: Not Amazing Nor Disappointing - Ahead of Wall Street

  3. Bull of the Day: HCI Group (HCI) - Bull of the Day
    Stock Analysis

    Bull of the Day: HCI Group (HCI) - Bull of the Day

  4. Bear of the Day: GrafTech (GTI) - Bear of the Day
    Stock Analysis

    Bear of the Day: GrafTech (GTI) - Bear of the Day

  5. Stay Away from REITs Despite Low-Rates? - Industry Outlook
    Stock Analysis

    Stay Away from REITs Despite Low-Rates? - Industry Outlook

Trading Center