Recently I had an interesting discussion regarding dual class share structures and how it impacts a company’s fundamentals and valuation. Now if a company had a dual class structure where they offered only class A shares to the public, the investing public who buys a stake in the business will only be entitled to a single vote compared to maybe 10 votes for a class B stock. In the case of Berkshire Hathaway, class B holders have 1/200th the voting power of class A shareholders.
Whether it be 1/10th or 1/200th the voting power, is the difference in voting power all there is to a dual class structure?
Disliking Dual Class Shares
Many investors dislike dual class shares, but there also seems to an unfair prejudice towards it – acutally, I would call it unrealised prejudice, but there is a reason to dislike it. Shareholders of the lower class are paying up without getting much say in the direction of the company, while the founding families or executives financially own a smaller piece of the pie, yet are entitled to super voting rights. Of course people dislike this idea. It leads people to believe that companies with such structures are downright unfair and not shareholder friendly.
Another negativity surrounding dual class shares is that if the family or executive team owns a large portion of the company, they will not be held accountable for mistakes made. Family and friends being the kind, generous and loving people they are, may probably end it with a stern face and a little tap on the wrist. They don’t really have to deal with the furious mob of sharesholders wanting their heads. But then again, it may be better than shareholders forcing a change in CEO’s every few quarters because one couldn’t clean up after the previous CEO and thus creating more mess. It’s ironic how shareholders acclaimed Stan Oneal for his decisions related to subprime mortgages during the housing bubble but then sent him to the slaughterhouse when the bubble burst.
Liking Dual Class Shares
The reasons stated above are perfectly valid to dislike dual class structures and move on. However, don’t rule it out just yet. Did you know The New York Times Company, The Washington Post Company, Dow Jones, Berkshire Hathway, Ford, K-Swiss and Google, yes Google, are all dual class share companies? I’ve never looked too deeply into Google so I was surprised to see it in this category. Let’s hear Google’s voice of reason.
The main effect of this structure is likely to leave our team, especially Sergey and me, with increasingly significant control over the company’s decisions and fate, as Google shares change hands. After the IPO, Sergey, Eric and I will control 37.6% of the voting power of Google, and the executive management team and directors as a group will control 61.4% of the voting power. New investors will fully share in Google’s long term economic future but will have little ability to influence its strategic decisions through their voting rights. …
Google has prospered as a private company. We believe a dual class voting structure will enable Google, as a public company, to retain many of the positive aspects of being private. We understand some investors do not favor dual class structures. Some may believe that our dual class structure will give us the ability to take actions that benefit us, but not Google’s shareholders as a whole. We have considered this point of view carefully, and we and the board have not made our decision lightly. We are convinced that everyone associated with Google—including new investors—will benefit from this structure. However, you should be aware that Google and its shareholders may not realize these intended benefits. …
As an investor, you are placing a potentially risky long term bet on the team, especially Sergey and me. The two of us, Eric and the rest of the management team recognize that our individual and collective interests are deeply aligned with those of the new investors who choose to support Google. Sergey and I are committed to Google for the long term. The broader Google team has also demonstrated an extraordinary commitment to our long term success. With continued hard work and good fortune, this commitment will last and flourish. – Google IPO Letter
To simplify, Google is saying that a dual class of shares will allow them to focus on the long term business. That is probably the biggest advantage to a dual class structure. Wall Street is so focused on each quarter and estimates that they forget a stock is a business that will sometimes have to forfeit a short term profit in order to reap large long term gains. As investors, shouldn’t we also be looking for companies that are trying to create long term wealth rather than squeeze short term profits here and there just to please analysts?
A Different Price on Shares
If only one share class is available to the public, we tend to think the price of that stock is what Morningstar, Google/ Yahoo finance is showing (note, Google & Yahoo don’t always show the current numbers). But looking at Berkshire, which trades both classes, class B is about 1/3 the price of class A stocks. Why? because the additional voting power warrants a premium to the inferior class. Most companies however, do not operate as transparently as Berkshire. I like KSWS for their candidness, long term perspective and shareholder friendliness but the price of the share would be different if we consider that both class A and B shares are fairly entitled to the company value. That is, the current price only reflects class A’s number of shares outstanding. If we take the number of shares outstanding as both class A and class B shares, the price of KSWS would seem to be less than what it is currently trading for.
If Berkshire B stocks are 1/3 the price, does that mean the public shares for KSWS should be 1/3 of its listed price? Maybe, maybe not. That’s what I’m trying to research and figure out.
Additional Input Regarding K-Swiss
When I bought K-Swiss, I did not consider that the price only reflected class A shares. (edit: in actual fact I was only looking at the shares outstanding numbers. I did not look properly at how many shares each class had outstanding. Also remember that Google and Yahoo makes many mistakes when writing up financial info so it is best to go to the source. Sorry about this mistake.) A new valuation now could potentially bring the intrinsic value lower. However, I am continuing to bet that K-Swiss will recover and believe the negative side of dual class shares do not apply to KSWS.
- The CEO, Steven Nichols, has been in the footwear industry his entire life. He knows the industry inside out. He bought K-Swiss when it was on the brink of bankruptcy and made it profitable in 3 years.
- Candid and transparent management. Open about problems it is facing and plans to resolve them.
- Emphasis on long term wealth. Shareholder friendly.
- A majority of the current management team have been with the company for over 10 years. Low turnover can derive that management has good chemistry.
- The current management team has been through 2-3 such cycles as it is now enduring. Experience in difficult conditions is abundant.
- Maintaining a design/model for a much longer period than the usual footwear industry allows KSWS to profit by reducing designing and manufacturing costs and helps to identify the brand.
- New updated designs with upcoming designers and stars (Sebastian Foucan, Anna Kournikova, Joel and Benji from Good Charlotte) and marketing campaigns to create brand awareness.
- They have a large cash base which allows them to continue investing in new footwear, overseas operations, new retail stores and other business opportunities even in a difficult economic environment.
- A large portion of their security investments are tied to riskless treasuries. No subprime or risky investments with these guys.
- Large portion of sales coming from overseas growth.
K-Swiss are definitely finding it difficult at the moment but I believe the current problems can be overcome.
Edit: This post is featured on “The Festival of Stocks #85” at Can I Get Rich On A Salary.