Eric Schmidt, Sergey Brin and Larry Page. Photo by Joi Ito.
What were Google’s top executives thinking when they decided to fold their company, and thus one of the planet’s most successful brands, into a unit of a newly formed enterprise called Alphabet?
There were a lot of sound reasons for the move, and I think one of them can be found in three letters: T-A-X.
Google, specifically the search engine that almost all of us use in our everyday life, throws off a lot of cash. Google, specifically the rest of the company’s ventures that we seldom touch in our daily life (with all due respect to Android users), also spends a lot of cash. But even with all the spending, the cash pile has mounted to a respectable $70 billion or so.
As an investor, I don’t generally like to see companies build huge cash hoards - in theory. If they can’t deploy it effectively in a reasonable period of time, and if they don’t need it for current and future operations or growth of the business, companies ought to distribute excess cash to shareholders. That is especially true in an era when the cash earns very little while on deposit in banks, and when government regulators and plaintiffs’ attorneys are always on the lookout for the next deep pocket to exploit.
But we don’t live in a theoretical world. We live in a practical one, in which it makes practically no sense for public companies like Google to pay big dividends to shareholders, though Google is hinting it might start paying at least something. The Wall Street Journal reported last month that Ruth Porat, then Google’s chief financial officer and now Alphabet’s CFO as well, told investors that Google would keep an eye on expenses and hinted at the possibility of a dividend or stock buyback. While analysts did not predict a near-term dividend after the Alphabet announcement, Google has not said anything on the subject either way.
Under the archaic and counterproductive U.S. corporate tax system, any income paid as dividends is taxed twice, first at the corporate level and then to the shareholder. And the earnings Google is making and, presumably, stockpiling offshore can be kept there for the time being without triggering U.S. tax at all. On the other hand, if Google takes money from its existing cash cow (Google Search) and builds successful new businesses, it will have a range of options that include spinoffs and divestitures to make money on its shareholders’ behalf, in some cases without triggering the same sorts of punitive taxes that dividends would.
In addition to the tax benefits, reorganization may well allow for better management. In his announcement Larry Page, the co-founder and former CEO of Google and the new CEO of Alphabet, described the new model he and Sergey Brin envision for the new organization: “to have a strong CEO who runs each business, with Sergey and me in service to them as needed.” By making different sections into relatively autonomous units, Alphabet will allow for different management strategies to address different challenges. Some commentators have suggested Alphabet will allow Google to compete for more “out there,” futuristic projects while protecting its core business.
Even if Google decides not to pay a dividend, it is not a given that I can invest the money any better than Google can do so on my behalf. True, Google has not yet demonstrated that it can turn its speculative ventures like driverless cars or computerized eyeglasses into moneymaking ventures. And it is also true that the guts of the Google moneymaking machine is still the basic idea of selling ads alongside content that other people paid money to generate, which is hardly revolutionary these days.
But what Google has demonstrated is a knack for invading, disrupting and co-opting other people’s businesses. Microsoft failed to make Windows a popular mobile operating system, in contrast to Google’s success with Android. Google’s Chrome has also taken a big chunk of the browser market from Microsoft, while Chromebooks have snapped up a smaller but significant share of the low-end notebook computer market. (A market, incidentally, that Apple and Google are together helping to shrink with increasingly capable phones and tablets.) And while Google gives away the consumer version of its Gmail service, a lot of companies pay real money for upgraded commercial versions, as well as commercial versions of applications like Google Docs and Google Sheets that are taking business away from Microsoft’s Office suite. And Google is one of just a handful of companies positioned to become leaders in the growing field of cloud-based storage and application delivery.
Google is a credible threat to break the cable and telephone duopoly in broadband Internet access, too. It has the money to build out competitive networks, as it is already doing in some test markets. And unlike Comcast and other cable providers, it has no vested interest in preserving the old programming bundle. Instead, it has a video platform - YouTube - that is already delivering user-paid content as well as significant ad revenue.
These are not the sort of people you make money betting against. If you are a shareholder and they are working on your behalf, they have certainly earned the benefit of the doubt. Alphabet looks like a sensible structure for a company that has already established one wildly successful business and has several other good ones well on the way, and whose leadership has shown an ability to anticipate and meet customer needs well before customers are aware of those needs.
So my answer, if you ask me whether I like Google’s Alphabet move, is a simple Y-E-S.