Bloomberg News

Google Traders See Opportunity in Confusion on New Shares

March 26, 2014

Google Headquarters

Google Inc., the biggest search-engine operator, will effectively split its stock when more than 330 million nonvoting Class C shares hit the market on April 3, ending a process that began two years ago. Photographer: Tony Avelar/Bloomberg

Google Inc. (GOOG:US)’s strategy to cement control for its founders by creating a third common equity class drew a lawsuit from institutional investors. Now it’s piquing the interest of equity traders.

The biggest search-engine operator will effectively split its stock when more than 330 million nonvoting Class C shares hit the market on April 3, ending a process that began two years ago. The most likely outcome is that Google’s share price falls by half and the new series trades in lockstep with the old, according to Jeffrey Burchell, co-chief investment officer of Aston Hill Financial Inc. in Toronto. Still, he’ll be on the lookout for signs of confusion in the marketplace.

A trading opportunity would arise should the shares veer apart even though Google is taking precautions to prevent it, he said. While dual-class equities typically diverge in the U.S., Google’s may not because of an unusual arrangement in which it will reimburse holders of the new Class C shares should they fail to keep up with the existing A stock. Google’s B class, which has extra voting rights, doesn’t trade publicly.

“Something as stupid as that might exist for half a day, where if people get confused about the different rights and obligations of the two different shares, and we might actually make money on it,” Burchell said. His firm manages about C$7 billion ($6.27 billion). “We don’t think it will happen, but we will be here watching it, and if there’s the slightest anomaly we have the structure to adjust.”

New Series

Google, based in Mountain View, California, unveiled in April 2012 its plan to create a new series of nonvoting Class C shares, to be distributed as a dividend on April 2. The action was held up when a Massachusetts pension fund and other investors filed a lawsuit that disputed its fairness from a corporate governance perspective. Google settled the complaint in June.

Google fell 2.3 percent to $1,131.97 at 4 p.m. in New York, the lowest level in almost two months. The stock is up 1 percent this year.

Co-founders Sergey Brin and Larry Page maintained control after Google’s 2004 market debut using Class B shares that carry 10 votes compared with one vote for each Class A share. The two have more than 56 percent of the vote and own about 15 percent of the company’s outstanding equity, according to June court filings.

‘Classic’ Split

Even though Google’s shares outstanding will more than double when it creates the new shares, the company anticipates the distribution to act like a straightforward stock split. Google has about 280 million Class A shares trading for $1,158.72 apiece.

“We expect that the market price for the shares of Class A common stock will generally reflect the effect of a 2-for-1 stock split once the dividend is distributed,” the company said in its 10-K regulatory filing. Matt Kallman, a spokesman for Google, declined to comment further.

“It’s a classic 2-for-1,” said Kevin Prunty, senior vice-president of equity trading at Raymond James & Associates Inc. in New York. “I don’t see the true arbitrage right now given what they’ve said. In order to have an opportunity there has to be some disparity, an advantage, to owning each class of stock. And I’m not seeing a huge gap.”

Google’s share arrangement has precedent in the American stock market, where voting and nonvoting shares usually trade for different prices. Discovery Communications Inc. (DISCA:US) A shares, with one vote each, trade at $83.02 while the nonvoting C shares closed at $76.57. Comcast Corp.’s voting shares have higher volume and trade at about a dollar more than the cable provider’s nonvoting shares.

Vote Minimized

“With most of these things, where there’s two classes, there is a bit of a difference,” said Daniel Ernst, an analyst at Hudson Square Research in New York. “But you’ll only get some kind of material difference that’s investable in small-cap, less liquid names. With something this big and this liquid, it’s pretty much going to be a non-event.”

The voting privilege attached to Google’s Class A shares is minimized by the existence of Brin and Page’s Class B shares, said Brian Wieser, a senior research analyst at Pivotal Research Group LLC in New York.

“The founders maintain control and investors can choose whether to go along for the ride,” he said. “It’s one of those things where there are reasons why someone might make cute trades, or have a strategy around why voting shares might perform differently, but it won’t be related to the fundamentals of the company.”

Founder Concessions

The creation of the new C class will allow Brin and Page, who is also chief executive officer, to issue stock to compensate workers or make acquisitions without loosening their grip on the company.

Unhappy shareholders sued in a Delaware court, contending the founders were seeking to use the stock-reclassification plan to unfairly entrench their control of Google, one of the world’s five largest companies by market value.

The company made two concessions to settle the lawsuit. The first bars Page and Brin from selling Class C shares unless they sell an equal number of Class B super-voting shares. The founders need approval from independent directors (GOOG:US) to get around the restriction.

The second calls for Google to make up a portion of the average price difference between the public classes over the first trading year. The company would make Class C holders whole at a 5 percent spread and pay a diminishing portion of the gap if it is less than that, according to a regulatory filing.

The plan to reimburse Class C holders should dissuade traders from paying more for Class A shares, Burchell said.

‘True-Up’ Mechanism

“The true-up mechanism is the unique thing that will keep the two stocks going in the right direction,” he said. “In absolute fundamental analysis, voting rights have some value. So there is a tiny, tiny bit of value that should be ascribed to the A shares over the C shares. But there’s now this mechanism that will kick in.”

Nasdaq OMX Group Inc., operator of the Nasdaq Stock Market where Google shares are listed, will add the nonvoting shares under the “GOOG” symbol on April 3. The Class A shares will be renamed “GOOGL.”

Traders can begin buying and selling in advance of the new classes being issued in a process known as when-issued trading starting March 27, the dividend’s record date.

Arbitrage Opportunities

Arbitrage opportunities can occur during when-issued trading because the new shares may not have much price history, said Gareth Watson, vice-president of investment management and research at Richardson GMP Ltd. They are most prevalent before an initial public offering, but will be limited in this case because Google shares are heavily traded and have a reference price, he said.

“If you trade it heavily you could make money just on volume,” Watson said. His firm manages about C$28 billion. “But I don’t think there will be an opportunity where market forces will create a massive gap in valuation and somebody will make a killing on this.”

S&P Dow Jones Indices LLC, the company that operates the S&P 500, plans to include both Google classes in its indexes that currently contain the A shares. The company initially intended to exclude one of the series at its quarterly rebalancing in June as it normally only carries a single class of any member’s stock, according to a March 11 statement.

New Rule

Instead, S&P Dow Jones made an exception for Google, and its benchmark index will have 501 listings following the dividend.

S&P Dow Jones was already planning to apply the multiclass listing structure to all U.S. indexes, but hadn’t determined when, said David Blitzer, chairman of the index committee, in a phone interview from New York. It now says that will occur after the quarterly rebalance in September 2015, creating a situation where there may be more listings than companies in any given index.

The company applied the new rule to Google because index-fund managers and exchange-traded funds that track the indexes may have been forced to sell the excluded class and then add it back 18 months later, Blitzer said.

“To have not included both share classes and then come back a year later to do it, it would’ve been silly,” he said.

There are about a dozen stocks in the S&P 500 with multiple classes, and Blitzer expects most won’t qualify for inclusion because one of the classes doesn’t meet liquidity requirements.

‘Probably Not’

Nasdaq indexes will contain both Google classes until June 23, when the exchange operator will remove the Class A shares during its quarterly rebalancing.

That realignment may cause some funds to sell the excluded class, Watson said.

“It will be determined by the investment policy statement of each fund, and what it states about what they are or aren’t allowed to do,” he said. “It’s tough to answer because you don’t know what the internal rules are for each fund out there.”

The rebalancing could lead to a short-term spread between the share classes, said Sadiq Adatia, chief investment officer at Sun Life Global Investments in Toronto.

“You will probably see a little bit of a price divergence, not a massive difference by any means,” Adatia said. His firm manages about C$7.8 billion, including shares of Google. “If you’re a massive trader with a big amount of capital, you might make that move, but for the average investor probably not.”

To contact the reporters on this story: Eric Lam in Toronto at elam87@bloomberg.net; Gerrit De Vynck in Toronto at gdevynck@bloomberg.net

To contact the editors responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net Jeremy Herron


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