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3 Things Google Investors Should Know About Alphabet

“If the conglomerate form is used judiciously, it is an ideal structure for maximizing long-term capital growth.”

—From Warren Buffett’s 2014 shareholder letter

By now you’ve likely heard that Google Inc. (NasdaqGS: GOOG, GOOGL) has a new look—one that recalls the massive American conglomerates that saw their heyday in the 1960s.

In Google’s case, the change starts at the top, in the form of a new holding company called Alphabet. In his announcement of the move on August 10, Google CEO Larry Page described the name as a play on the term “alpha,” which means “investment return above benchmark.”

Under the new structure, Google co-founders Page and Sergey Brin will head up Alphabet, whose main business will still be Google (ad revenue from the search giant’s websites, or those of its partners, accounts for about 90% of the company’s total).

The biggest change investors will see will be in Google’s (er, Alphabet’s) financial reporting. Unlike today, results from Google’s core operations (which will now mainly include search, maps, YouTube and Android, along with popular services like Gmail and the Chrome web browser) will be broken out from the combined figures from Alphabet’s other ventures.

The Alphabet structure will be phased in over the next few months, with the new reporting regime in place for Google’s fourth-quarter results, which it typically releases at the end of January.

Just as important, each of these new subsidiaries will also have its own CEO.

If you’re not familiar with the company’s non-search businesses, they’re an eclectic bunch that includes Google’s so-called “moonshots”—innovations that aren’t expected to turn a profit for years, if ever (the thinking being that if the company invests in a number of these areas, it boosts its odds of hitting on a winner).

They include Life Sciences, with innovations like contact lenses that can measure blood-glucose levels (for managing diabetes); Calico (fighting aging); Nest (smart home thermostats); Google Fiber (high-speed Internet), Google Ventures (financing); and more speculative initiatives being carried out by the Google X lab, such as self-driving cars and drone delivery.

If you’re a Google investor, you won’t have to do anything. Both of the current share classes will switch over to the same number of Alphabet shares when the change takes effect, and Alphabet will continue to trade on Nasdaq under the GOOG and GOOGL symbols.

Berkshire Hathaway for the Tech Set?

Alphabet’s structure has drawn comparisons to Warren Buffett’s Berkshire Hathaway (NYSE: BRK.A, BRK.B). It’s true that both companies are made up of unrelated, independently run subsidiaries, but beyond that, there are some glaring differences.

For example, Berkshire consists of more than 80 mostly profitable businesses, while most of Alphabet’s ventures operate in the red, at least for now, with the main Google business continuing to drive revenue and earnings.

Their growth strategies are also very different: where Buffett built Berkshire mainly by acquiring undervalued companies, Alphabet’s growth will be mostly internal. Though Google is no stranger to acquisitions, outside of blockbusters like Motorola Mobility ($12.5 billion) and Nest ($3.6 billion), it has mainly targeted smaller, private tech firms that add something to its current services, like navigation app Waze and music-streaming service Songza.

Nonetheless, Google—and its investors—stand to benefit from the change. Here are three reasons why:

  • A clearer picture: How much money Google is devoting to its more “out there” ideas is a question that’s long vexed Wall Streeet, and under Alphabet, investors will be able to get a better sense of this. (Chairman Eric Schmidt said in June that most of the company’s investments still go into its main businesses.)

    At the same time, they’ll be able to get a clearer picture of Google’s main businesses. But keep in mind that the breakout likely won’t be too granular.

    “It may be overly optimistic to hope for discrete business unit breakouts for the display network business … YouTube, other Doubleclick-related activities, Google Play, Android, etc.,” Pivotal Research analyst Brian Wieser said in a note to investors quoted in an August 11 Adweek article.

    “Further, it remains to be seen whether or not key cash flow items such as capital expenditures—which are not commonly broken out by companies with multiple reporting segments, but which are particularly critical for Google—will be disclosed at the segment level.”

  • It could set the stage for spinoffs: Once each subsidiary is split out into a separate division, it follows that Alphabet may go the rest of the way and set these businesses up as separate publicly traded firms. (The fast-growing YouTube is one possibility that routinely pops up in the business press.) Spinoffs generally turn out well for investors, because they tend to outperform their non-spinoff peers over time.

    As for YouTube, there was nothing in Page’s announcement to suggest Alphabet will separate the video-streaming service from the “new” Google.

  • It could help attract (and retain) talent: By creating new CEO positions, the company gives its upper management a continued career path, with the potential for a greater degree of independence. That’s key, particularly in the cutthroat world of technology, where keeping top performers out of cash-rich competitors’ clutches is always tough.

    A number of Google execs have gone on to take high-ranking positions at other tech firms, including Marissa Mayer (now CEO of Yahoo), Sheryl Sandberg (COO of Facebook), Chris O’Neill (CEO of Evernote) and Nikesh Arora (COO at SoftBank Corp.).

    The upward moves inside Google/Alphabet have already started, with product chief Sundar Pichai slated to take over Google’s corner office from Page later this year.

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