Break-ups and stock prices (Big issue 6-19-2019)
Historically investors have done well from break-ups.
Welcome to Big, a newsletter about big tech, monopoly power, and the politics of business. Today I want to answer a question about what breaking up a big tech company would do. Would it increase the stock price of the company?
Stock prices are not a reason to break up a company, but I get the question a lot because the stock market is an instrument for valuing our enterprises. And there’s something disconcerting about policy that would reduce the value of our businesses.
For example, here’s a segment on CNBC. Brent Thill at Jeffries joined Squawk Box to say that, though he doesn’t think a break-up will happen, that “Regulatory is the number one question asked by investors.”
Big tech - Facebook, Google, Amazon, Microsoft, and Apple - are the largest and most liquid names in the stock market, sometimes known as ‘hedge fund hotels.’ Taking other peoples’ money and investing it is based on groupthink. It’s fine to lose money, but only as long as everyone else is losing it, and vice versa. So mostly analysts want to make sure they aren’t out of step with the crowd, and the crowd right now is concerned about antitrust and big tech.
I have three examples suggesting they shouldn’t be so concerned, or should even seek a break-up.
From Kerosene to Gasoline
The granddaddy of all monopolies and break-ups is Standard Oil, John D. Rockefeller’s oil monopoly at the turn of the century that structured the most important business of the era. In 1911, the Supreme Court broke his company into 34 components, many of which went on to be some of the most powerful companies in the world, such as Exxon, Mobil Pennzoil, Conoco, Chevron, and so forth. Shareholders did fantastically well in the break-up, with Rockefeller quintupling his wealth.
Why did Standard Oil’s component parts do so well? And was the break-up responsible for higher stock prices? The answer is that the older monopolistic business structure was inefficient, and breaking up the company helped unleash technological innovation in the industry by enabling the use of a relatively unimportant part of Standard’s portfolio: gasoline.
In 1909, a Standard-employed chemist named William Burton invented “thermal cracking,” which was a way to vastly improve the process of turning oil into gasoline. The Indiana branch applied to headquarters to put $1 million into developing the process, but HQ said no. The company primarily sold kerosene, and while cars were increasing demand for gasoline - what was then seen as a relatively useless byproduct of oil refining - such an investment was simply too risky to what had become a lazy, slothful monopoly. After the break-up, Standard Oil of Indiana simply went ahead and began using thermal cracking, and eventually the whole industry was licensing patents from the company. While stockholders did fantastically well, Indiana shareholders did even better. The era of cheap gas came, or at least was accelerated dramatically, by the break-up.
You might think Google or Amazon are innovative. But at the time, most people thought Standard Oil was innovative. In fact, all are financial holding companies that capture the innovation of others, and hold it back. Stock prices reflected that.
In the 1930s, Congress passed a law called the Public Utility Holding Act, which broke up the complex financial holding structures that had captured control of electric utilities across the country. This law was one of the most controversial fights of the entire New Deal. What it ultimately did was force utilities to register with the Securities and Exchange Commission, and then dissolve themselves if they stretched across state lines unless the SEC gave them a waiver. The rationale for the law were the financial games and trickery played by utility barons, most famously, Samuel Insull, who temporarily left the country in the early 1930s to avoid capture by the authorities.
Utility financiers of the time used holding companies to disguise assets, manipulate stock prices and regulators, and hand back assets among subsidiaries to avoid income taxes. Will Rogers described holding companies as “something where you hand an accomplice the goods while the policeman searches you."
At their height in the 1920s, holding companies were blue chip stocks that everyone held. Of course it all eventually collapsed in the stock market crash. Ten shares of one of the utility holding companies of the day - Middle West Utilities - worth $500 in 1929, dropped to $1.25 in 1933.
So what happened when the split-ups happened? I’ll let Congressman Emanuel Celler explain. Here’s what he wrote in 1950.
“The big utility holding companies have now been pretty well split up and the results look good. When Commonwealth and Southern started to take the treatments in 1938, the total value of its securities was only $135,000,000. By 1949, investors had received, in the breakup, cash and securities worth $415,000,000. At the same time, the consumers are getting electricity at lower rates. If this is ruining an industry, we might try to see if there are any more than that need the same kind of ruin.”
It turns out that when financiers control businesses within opaque structures, no one benefits but the financier.
AT&T versus IBM
For much of the 1970s, both AT&T and IBM were subjected to antitrust suits for their monopolistic market positions and use of anti-competitive tactics. The suits were so serious IBM prepared a break-up plan by reorganizing its divisions. For a variety of reasons mostly having to do with happenstance, Reagan’s antitrust chief, William Baxter, announced the resolution of the AT&T and IBM antitrust cases on the same day in 1982.
Baxter dropped the IBM case because he felt IBM was being held back by government overreach, but, unusually for a law and economics conservative, chose to break up AT&T because he disliked cross-subsidies between the regulated subsidiaries and unregulated long-distance and equipment manufacturing subsidiaries. The government was giving an unfair advantage, he felt, to the unregulated AT&T subs. In addition, AT&T gained an important benefit in the break-up, which was an end to the 1956 decree prohibiting the company from entering the computer business. By letting AT&T into the computer business, Baxter thought IBM would finally face competition.
So what happened, at least for investors? Well, IBM did not do well, while the many component pieces of AT&T did fantastically well. Here’s Fortune magazine in 1992.
The market value of AT&T's common stock just before the settlements were announced in January 1982 was $47.5 billion. In late June of this year, the market value of the eight successor companies together -- the stripped-down AT&T, plus Ameritech, Bell Atlantic, BellSouth, Nynex, Pacific Telesis, Southwestern Bell, and US West -- came to no less than $180 billion.
AT&T sold for less than book value in 1982, and its components sold for twice book value ten years later. Meanwhile, IBM increased its stock price above book value by just 30% in that time. IBM throughout the 1980s had better technology, more capacity and a better reputation than Microsoft. But like Standard Oil in the 1900s, headquarters overruled the engineers. Had IBM simply been split up, history would have been very different, and IBM stockholders, many of whom had handed down the stock through their family for decades, would have made out much better than they did.
Breaking Up Big Tech Today?
Years ago, I used to use an RSS reader called Bloglines. Google bought the product, and ultimately shut it down. This isn’t because it was a bad business, but because it didn’t move the revenue needle for a company as big as Google. Bloglines could have been a great mid-size business for someone, but it was a distraction for Google executives. How many technologies like that are locked in Google, Amazon, or Facebook? How many business people and engineers are waiting to be liberated?
I suspect, many. Liberating business from monopoly would help our society, it would help the marketplace, it would help consumers, and it would probably help investors. After all, if you break up Google, a shareholder of Google would also become shareholders of YouTube, DoubleClick, Android, Maps and all of the component parts. And each of those businesses would be able to innovate and develop new industries. I mean, mapping is amazing. How much are we not getting because Google uses its monopolistic mapping subsidiary to mostly benefit its targeted ad business?
That said, broadly speaking, those who believe in the philosophy of populism bringing back antitrust do not particularly respect stock prices or investors. And Wall Street is driven by ego and power as much as money, so even if break-ups made sense, bankers would probably despise governments seeking to force them. Fundamentally merger law or structural separations is simply mergers and acquisitions, but done by democratic institutions in the form of antitrust agencies. And that Wall Street investment bankers cannot abide.
Investors would profit if they did so abide, but they’d also become less important.
Thanks for reading. This is the second issue of Big. Let me know what you think by either telling me on Twitter at @matthewstoller or by emailing me at stoller at gmail.com.