Silicon Valley Engineering VS Wall Street Engineering

I think one problem we’ve had is that people who are smart, creative and innovative as engineers went into financial engineering.

– Walter Isaacson

 

FinancialEng

What do Citrix & Yahoo have in common? Along those same lines, what do Facebook and Google have in common?

These companies typify the battle that’s brewing between Silicon Valley Technology Engineering & Wall Street Financial Engineering!

Since the early days of Silicon Valley with Shockley Semiconductor, Fairchild Semiconductor and Intel, our tech industry has been intertwined with venture capitalists & wall street. Technology companies need access to cash to fund the engineering efforts. VC’s are only too happy to supply the funds in hope of future payoffs. When that payoff happens in the form of an IPO, Wall Street too gets their pound of flesh. Over the years, asset management companies, LBO specialists, investment bankers, hedge funds & private equity funds too got involved in the game by investing in private & public companies, taking the public companies private, buybacks, special dividends, divestitures, spin-offs, mergers, etc. – quite a financial engineering bouquet.

In the recent years, beyond writing investment checks, some of these funds have been taking a more aggressive stance in dealing with the tech companies that they have invested in. Initially, they try to work behind the scenes with the company’s management team to drive the changes they seek. If that doesn’t work, they lobby & fight publicly (open letters to management, proxy wars, board room battles, lawsuits, etc.) to drive changes – hence the term “activist investors”.

Yahoo: Yahoo has been going through a turmoil in the recent years – revenue/profit drops, lack-luster product strategy, non-performing acquisitions & “acquihiring”, losing market share, talent exodus, competing with Google, Facebook & Microsoft, etc. Clearly, the investors who plunked money into Yahoo aren’t too thrilled. Hedge fund investors like Starboard Value are openly pushing for major changes such as selling Yahoo’s core business, layoff employees, replace executive management, etc.

Citrix: Meanwhile, Citrix has been facing its own share of pressure from its activist investor Elliott Management. Driven by Elliott, Citrix has been divesting product lines, spinning out its GoTo products, laying off employees, etc.

These moves on the part of activist investors are designed to improve the company’s stock value & EBITDA multiples in the short term – leading to a higher ROI for the investors. However, these activist investors are probably not thinking about the long term impact on the company, employees, product strategy, synergies, customers and partners. These investors have a single minded drive of improving short term ROI and nothing but ROI – and it’s hard to fault them because that’s how the Wall Street gets compensated.

So, how are companies supposed to protect themselves from these short term ROI driven investors? How do they control their destiny?

Turns out, Facebook and Google have figured that out!

Facebook: Facebook instituted a dual-class stock structure years before the IPO – class A & class B shares where class B shares carry ten votes per share while class A shares carry one vote per share. Mark Zuckerberg owns class B shares while the rest of the mere-mortals gets class A shares. As of few months ago, Zuckerberg controls 55% of the voting power even though his share ownership is much lower. What this means is – Zuckerberg and his team have absolute control over the company strategy & direction. Investors and Funds have no ability to hold the gun to Zuckerberg’s head or do any financial engineering to drive short term ROI!

Google: Google being Google (aka Alphabet), takes this strategy one step ahead of Facebook. Google has a three class share structure – classes A, B & C. Class A shares (ticker:GOOGL) get one vote per share, class B shares get 10 votes per share while class C (ticker:GOOG) shareholders get zilch/zero/nada votes per share. Class B shares (with 10 votes per share) are owned by Larry Page, Sergey Brin, Eric Schmidt and a few other insiders. This structure puts Google’s reins firmly in the hands of the management team without any form of activist investor interference. This absolute control also makes it easier for Google to spend billions of dollars on the moonshot projects without having to worry about the second guessing investors!

While its reassuring to know that the likes of Mark Zuckerberg, Larry Page, Sergey Brin & Eric Schmidt have absolute control over their company’s destiny, over the long term, only time will tell whether that’s a good thing or not!

 

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