Wednesday, April 08, 2009

Google and the Temptations of Being Cash-Rich - DealBook Blog -

Several years ago Eric and crew at CyberLibris asked me for a list of my all time favorite finance papers. I could not find a link to it now but I do know that well in the top five was Michael Jensen's 1986 free cash flow paper. It was one of the first academic papers I read when I got to Rochester for my MBA and it immediately clicked. It later became the premise of my PHD dissertation and I use the ideas to this day in class.

In short, Jensen's Free Cash flow paper says that if firms have free cash flow (my dissertation and many other papers since have also looked at high levels of cash) tend to waste it by investing in negative NPV projects.

It appears that the analysts at Sanford C. Bernstein agree!

From the NY Times's DealBlog:

Google and the Temptations of Being Cash-Rich - DealBook Blog -
"Analysts at Sanford C. Bernstein are making their views on the subject unmistakably clear...(deleted stuff on Twitter)... said that Google and other successful Internet companies would generally be doing their investors a favor if they returned their cash to shareholders rather than using it to buy unprofitable start-ups.

The analysts argue that Internet companies have a bad track record when it comes to acquiring “pre-business-model” companies like Twitter, a popular microblogging service that has yet to produce profits — or even revenues. The Web is littered with examples of promising but ultimately value-destroying acquisitions, they wrote in a note to clients, citing deals like AOL’s $4.2 billion acquisition of Netscape and eBay’s $4.1 billion acquisition of Skype."
and later:
"It is worth noting that Google’s chief executive, Eric Schmidt, recently said his company doesn’t expect to be active in making acquisitions. In addition, Google paid for YouTube, the video-sharing service, with stock, not cash.

Even so, the analysts at Sanford Bernstein said they think Google should consider giving, say, $20 billion of its cash pile back to shareholders in a one-time dividend of about $60 a share."

Which fits the free cash flow story perfectly.

I guess it should be noted that the SIMM class that I teach does own a few shares of Google. Not sure how it is relevant , but I remember that as part of the SeekingAlpha agreement, I was supposed to list it.

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