G is for Google and C is for Conglomerate. This is how the markets learned their alphabet a Monday afternoon in August 2015.
Google Inc. (GOOGL), which reinvented the way the world accesses information, gave formal notice to Wall Street of its intentions to become a technology conglomerate by announcing a new parent entity – Alphabet Inc.,– that unites its widening interests and product lines. Apart from Google's core search business, the eight companies that comprise Alphabet span a diverse array of industries, from robotics, to life sciences, to healthcare and anti-aging.
In a blog post announcing the move, Larry Page — the CEO of Alphabet Inc. — said the new entity would help them take a long-term view and improve the “transparency and oversight” of their actions. The new entity, he wrote, was an “alpha-bet (Alpha is investment return over benchmark), which we strive for!”
Not much will change for investors in the reorganization. According to the SEC filing, each Google Inc. share would be swapped for an Alphabet Inc. share. Thus, the change has minimal consequences in terms of impact to bottom line and company direction.
That then begs the question: why did Google change its name to Alphabet?
The Wall Street Effect
When it debuted on the stock market, Google became Wall Street's darling. Its market capitalization increased by $27.2 billion – giving it a market cap bigger than Ford's (F) and General Motors's (GM) that first day of trading. That number was based on the market's assessment of the company's search business and turned out to be largely correct as Google's prowess in search powered its fortunes over the years.
The arrival of the social media brigade, however, blindsided Google. Even as the company was coping with Facebook's (FB) onslaught on its core business, the disintermediation of Web search into mobile apps further eroded Google's bottom line. Google's foray into social media was pretty much a disaster. (See Also: Can Facebook Become The Next Google?)
Perhaps the thinking was that Google could pioneer other industries, just as it started the search industry.
However, the absence of numbers related to the cost and operational expenses of Google's new or acquired ventures has made Wall Street nervous. Company chairman defended the moon shots to investors at this year's shareholders meeting.
The move was intended to help allay the market's fears by streamlining operations and providing investor visibility into the operations of Alphabet Inc.'s new ventures and acquisitions. It has helped Alphabet Inc. prove to investors that it can deliver profits even as it explores new markets and avenues for future profits. The company's stock price jumped in record numbers after CFO Ruth Porat spoke about “transparency” in its latest earnings call.
Through reorganization as a conglomerate, the move also lessens the glare of antitrust scrutiny on Alphabet. This is because each company within the Alphabet umbrella makes products for a different industry. Bunching all of them together under the search engine umbrella would have invited greater attention from regulators due to the unique nature of Google's business. With the new corporate structure, Alphabet Inc., can always argue that each company within its organization has operations independent of the search engine.
However, less obvious was the consolidation of power to be held by the two founders, versus the shareholders. The new entity was to be structured in a way that Page and Brin holds the majority of the voting rights, without the majority of the stock. This was done in order to prevent the company from drifting away from its vision due to pressure from investors to perform financially. (Take a deeper look: What's the difference between Google's GOOG and GOOGL stock tickers?)
Inventing A New Company Within A Company
Google's founders – Larry Page and Sergey Brin – have always had a healthy disregard for the impossible. They imbued this thought process into their company's DNA and it made Google a fount of innovation within Silicon Valley, a geographic area where innovation is a byword instead of a buzzword.
But fact of the matter is that many of its attempts at innovation have flopped. The company's attempts to reinvent itself as a hardware and Internet of Things player have also come under constant scrutiny by the media and Wall Street. Page, who returned as company CEO in 2010, lashed out against the criticism and called for a “safe place” for innovative companies to carry out experiments at Google I/O in 2013.
The separation between the Alphabet Inc,'s main business – search – and other companies provides the company with the “safe place” to carry out experiments. Each company within the Alphabet umbrella will be headed by a CEO, who will report into Page, which allows the respective head to determine the best course of action without worrying about its effect on the search engine cash cow.
The move also helps avoid negative PR through direct association with the search engine business, which makes money by inferring user interests. For example, Google's acquisition of home security company Nest raised privacy concerns.
The Bottom Line
According to the author of Google's ten commandments, Larry Page and Sergey always had a bigger picture of technology's role in the world. “Larry's vision was always to be something like General Electric (GE), and Google was only his first proof-of-concept,” he is quoted in the New York Times.
The reorganization seems to be Page and Brin's attempt to streamline operations to focus energies on new ventures and evolve Google from a one-trick pony to a conglomerate.