Snap (SNAP) and Tencent (0700:HK)

Yesterday, as part of its disappointing quarterly earnings announcement, SNAP revealed that Chinese internet giant Tencent has acquired a 12% stake in the company.

This is considerably less than it seems, however, for three reasons:

–US securities law requires that an acquirer make a filing–called a 13D–declaring its intentions once it has built a 5% voting interest in a publicly traded company.  It must also report every +/- 0.5% change in its ownership interest as long as the total holding remains at 5% or above.  Based on this rule, a quick reading of the Tencent headline suggests the Tencent move up came in at least one large chunk and fairly recently.  Not in this case, however.  SNAP has issued only non-voting shares.  So the SEC filing requirement doesn’t apply.  In fact, Tencent says it has acquired the stock in the open market over a lengthy period.  Therefore, the 12% stake is not a this-week vote of confidence by Tencent in the SNAP management.

–the stake was acquired in the open market, not from SNAP directly.  Therefore, the large amount of money Tencent spent on SNAP shares did not go into the company’s coffers.  It went to third-party holders exiting their positions.  So, yes, Tencent took out sellers who might otherwise have put downward pressure on SNAP’s share price.  But SNAP did not receive the benefit of a substantial cash injection.

–also, the fact that these were open market transactions does not signal the strong commitment to SNAP that a direct purchase of a block of shares from SNAP would have.  Tencent could disappear from the share register just as easily as it appeared.

Snap (SNAP): non-voting shares (ii)

Two potentially important issues arise with non-voting shares.  The underwriters and prospective investors in SNAP are clearly not worried about them.  Granted, they’re unlikely to emerge as actual issues in the near future, but here they are:

–value investors often buy shares in companies they believe are undervalued by virtue of  having bad management.  Their rationale is that management will change in one of several ways:  existing managers will learn from past mistakes and improve;  the board of directors will replace existing managers with better ones; shareholders will vote out current directors and replace them with better ones; the company will be taken over by a third party, which will toss out the incumbents and replace all of them with more competent individuals.

In the case of SNAP, management, the board and the voting shareholders are basically one and the same.  The likelihood of them firing themselves is pretty small.  And the chances of a hostile takeover are zero.  So the value investor argument for eventually buying SNAP shares that there’s a level below which they can’t go without triggering change of control doesn’t apply here.  So if things turn south with SNAP, the chances of rescue are small.

The results of this situation are plain to see in the Japanese stock market, where disenfranchised shareholders have had to watch their investment in family-owned company shares lie dormant for decades.

–change of control can happen voluntarily.  But does an acquirer have to buy non-voting shares in order to take the reins?  I don’t know.  But I don’t think the answer is clearly “Yes.”  Say Amazon decided to bid for the voting shares of SNAP at double the price of the publicly traded, non-voting ones.  AMZN could presumably then replace management and the board of directors and guide the company in any direction it chose–without buying a single non-voting share.  If this were to happen, my guess is that non-voting shares would plunge in value.  Years of expensive legal wrangling  would decide the issue one way or the other.

A third musing:   Can SNAP declare dividends for voting shares but not for non-voting?  The answer should be in the prospectus, which I haven’t read carefully enough to have found out.  But then I’m not interested in taking part in the IPO.

the issue of Snap’s non-voting shares

A time-honored strategy for entrepreneurial individuals or families to maintain control over their enterprises is to issue two classes of stock.  One will be held by the entrepreneurs, the other by the investing public.  Shares of the former type will typically have a high multiple, say 10x, the voting power of the latter.  If the number is 10x, the entrepreneurs will still control a majority of the votes even if they hold only 10% of the outstanding shares.

Hershey shares are like this.  So, too, the New York Times, News Corp, Facebook and Google.

A variant on this idea, often used outside the US, is to list and issue to the public only preferred stock, not common.  Preferreds vary.  They derive their name from the fact they have some “preference” or other over common (which are also sometimes called ordinary). It may be a higher dividend.  Most usually in the US, preferreds simply have a place in line in the case of bankruptcy in back of all creditors but just ahead of common stockholders–which, to my mind, is as small a preference as you can get.

Snap (ticker: SNAP), the parent of Snapchat, is taking this idea one step farther.  It currently has two classes of stock:  Class C which has 10 votes per share and which the company’s founders hold; and Class B that has one vote per share and which is held by key employees and venture capital investors.  Snap intends to go public by issuing Class A shares that have no voting power at all.  Third party investors will have to accept the fact from Day 1 that they will never be able to wrest control of Snap from its insiders.

Questions:

–Will investors stand for this?

–Are the A shares really stock?   …or are they a funny kind of option?

–What does this say about value investing in the 21st century?

The answer to the first question is apparently “Yes!!!”

 

More tomorrow.