Wednesday, August 2, 2017

Snap's IPO May Benefit Investors After All

By Rob Cox
Reuters
August 2, 2017

Snap's messages may disappear, but one thing could yet endure from its calamitous initial public offering: an incentive to treat shareholders more fairly. Inspired by investor discomfort over founder Evan Spiegel's decision to hoard all his company's voting rights for himself and a few of his bros, the compilers of America's most influential stock benchmark will henceforth bar multiple share classes. It's a victory for democratic capitalism.

The S&P Global unit that decides which stocks are included in the S&P 500 Index – to which investors around the world passively dedicate trillions of dollars of wealth – said on Monday it would no longer admit companies that violate the one-share, one-vote principle of corporate governance. That means Kappa Sigma brother Spiegel, whose company's public shares bestow upon their owners no say whatsoever in its affairs, will not be indoctrinated into a far larger and more important fraternity than the one he joined at Stanford.

There are many reasons to rejoice in this call by S&P Dow Jones Indices. In the short term, it means Snap's crummy performance won't be gumming up the party for hundreds of other companies in the benchmark. When Spiegel offered investors a chance to ride his coattails, enough of them acquiesced to the demands and delivered $3.4 billion of fresh capital. After a quick pop, their voluntary servitude has been rewarded with a quarter of disappointing results and a 23 percent decline in the value of their investment. That includes a 3 percent slide following the snub from S&P.

For all the fund managers and individual buyers who suffered through Snap, however, they can take comfort in helping pave the way for a precedent that ought to benefit future participants in American capital markets. The exclusion of Snap – or Blue Apron, another debutante with tilted voting rights that has watched 35 percent of its value incinerate since listing – should force companies to reconsider whether to create different classes of stock when they gather underwriters and prepare to seek money from new investors.

FTSE Russell, the index-compiling division of the London Stock Exchange, is trying to crack down on unequal voting rights, too, but the S&P is the only major Wall Street institution so far providing a carrot for enterprises to adopt this best practice. The U.S. stock exchanges, unlike big counterparts in London and Hong Kong, provide few restrictions on companies wanting to treat some investors differently than others, namely their founders and venture-capital cronies. That's why, for instance, Chinese internet juggernaut Alibaba opted for a New York listing instead of one in Hong Kong.

There is also no prohibition from the Securities and Exchange Commission, the guardian of investor interests in the United States, on hydra-headed equity arrangements of the sort Snap perpetrated. The agency tried to prevent them in the late 1980s, but the effort was shot down in court. And it goes without saying that underwriters are paid to enable whatever behavior best induces their chief-executive clients to hand over fees in the neighborhood of 7 percent of the value of stock they hawk.

It's hard to say whether S&P's new guidelines will encourage the next startup wunderkind, be it Airbnb or Uber, to give future investors the same rights accorded to, say, Brian Chesky or Travis Kalanick, the respective founders of those private firms. Like those who came before them, including Facebook's Mark Zuckerberg or Google's Larry Page, they may not need to worry about inclusion in the S&P 500 Index. Money will fly through the door to support their fast-growing organizations, whatever the conditions.

Facebook shares debuted at $38 and after stumbling a bit out of the gate have since more than quadrupled in value to around $169. And Google, now Alphabet, hit the public market at $85 a share nearly 13 years ago. It's trading at $933 today. By contrast, the S&P 500, to which they belong, has gained 123 percent since Google went public and around 88 percent since Facebook did (see graphic: Grandfathers of bad governance tmsnrt.rs/2hkpdXX).

Supplicants to feudalistic share structures might point to this as prima facie evidence that the S&P would have underperformed without the inclusion of these superstars. Take those shares out and the benchmark would have done poorly. Perhaps, but the counter-argument is that none of the companies necessarily would have fared any differently either if they had just one share class. One study published in May by an investor trade group also found that multiple classes of stock neither helped nor hurt a company's ability to deploy capital sensibly.

So far this year, Alphabet's C shares, which confer no vote, have modestly lagged those of its one-vote A shares, rising 18 percent and 20 percent, respectively. Its super-vote B-shares are held by Page, fellow co-founder Sergey Brin and other executives. Though the no-vote shares trade at a slight discount to the voting stock, this suggests that when a company is doing well, owners tend to benefit in tandem.

When times are tough, that may not be the case. Take Under Armour, the once-hot apparel maker which also has three share classes and just unveiled disappointing results and a restructuring. The ones that founder Kevin Plank first sold to investors in 2005 at $13 apiece now fetch $18.32, including an 8 percent slide on Tuesday. But since creating a new, no-vote class of stock in April 2016 they are down 60 percent. Those new vote-free shares immediately traded at a discount, and have lost 78 percent of their value.

The point is that today's stock market darlings won't remain so forever. When the inevitable growth plateau comes, they will be glad to be included in the world's most widely followed index, particularly if, as seems likely, the trend toward investing in low-fee funds that track indexes like the S&P 500 keeps outpacing inflows into the high-fee, low-return active variety. Index inclusion gives investors another reason to own their shares.

It's a trend that is arguably already benefiting the likes of Rupert Murdoch's Twenty-First Century Fox, Ralph Lauren, Tyson Foods, McCormick and Ford Motor, all of which are mature, even borderline ancient, companies with more than one class of stock that will be grandfathered in to the S&P 500. It's also another reason for Snap to disappear from investor portfolios for all eternity.


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