Dual share structure: The Google model spreads

May 27th, 2011
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Contributed by: Aswath Damodaran
Google rewrote the book for initial public offerings in two ways. One is that they bypassed the traditional investment banking syndicate for an auction (which is a good development) and the other is that they were unapologetic about the fact that they had two classes of shares and that the founders would hold on to the shares with the disproportionately large voting rights. While shares with different voting rights are par for the course in many parts of the world (Latin America, for instance), their use in the United States was limited to a few sectors; publishing and media companies such as the New York Times and the Washington Post have used the structure to allow the founding families to control these companies, with relatively small percentages of the overall equity.

Two factors played a role in containing dual class shares: the first was that, for decades, the New York Stock Exchange barred shares with different voting rights from getting listed on the exchange and the second was the fear of an adverse reaction from investors. Google was unfazed by either concern. It listed on the NASDAQ and institutional investors were so eager to hold the stock that they seemed to overlook the voting share structure (or at least not price it in).

So, what's the big deal with voting rights? Voting rights matter because they allow stockholders to have a say in who runs the company and how it is run. It is true that most stockholders don't use these rights and prefer to vote with their feet, but the voting power does come into use, especially at badly managed companies, where a challenge is mounted on management either from within (activist stockholders) or from without (hostile acquisitions). The argument I have heard from institutional investors for their benign neglect of different voting share classes at Google is that the company is well managed and that control is therefore worth little or nothing. There is a kernel of truth to their statement: the expected value of control (and voting rights) is greater in badly managed companies than in well managed ones. However, if you are an investor for the long term, you have to worry about whether managers who are perceived as good managers today could be perceived otherwise in a few years. (A decade ago, Cisco would have been ranked among the best managed companies in the world. Today, its management is under assault after ten years of bad acquisitions and under performance).

How does this play out in valuation? Once you have valued the aggregate equity in a company, you have to estimate the value of equity per share. When shares all have the same voting & dividend rights, you can divide by the total number of shares outstanding. When they don't, though, you may have to allocate the equity value differently to different share classes. Generally speaking, voting shares should trade at a premium over non-voting shares, but that premium should be larger in poorly managed firms than in well-managed firms. How much larger? I have a paper on the topic that does try to come up with a specific premium for voting shares.

The trigger for this post was the Linkedin valuation that I did yesterday. I valued the equity of the company at approximately $ 2 billion, but I was unforgivably sloppy about getting the per share value. I used the 43.31 million shares that Yahoo! Finance listed as shares outstanding and I should have known better. Checking the prospectus for Linkedin, here is what I see:
* 7.8 million class A shares (all of the shares offered in the IPO are class A shares)
* 86.7 million class B shares (which have ten times the voting rights of class A shares)
Dividing the value of equity by 94.5 million shares yields a value per share of $21.51/share, but even that may be an over estimate. If we assume that the voting shares trade at a premium of 5% over the non-voting shares (the 5% is the average premium for voting over non-voting shares in US companies), the value per share for the non-voting shares drops $ 20.57:

Value per non-voting share = $2,033 million (7.8 + 1.05*86.7) = $20.57

Reading the prospectus, though, things get worse. Linked in notes that it has options outstanding on roughly 17 million shares, with exercise prices ranging from $6 to $23. Needless to say, all those options are deep in-the-money now and while I don't have information on vesting, it behooves us to act as if these options will be exercised. Using an average exercise price of $15, the value per share drops further to about $20.

Bottom line: Getting from value of equity to value per share gets progressively more difficult as you add shares with different voting rights and outstanding options to the mix.
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