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Corporate governance is not a four-letter word

02 October 2020

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Russell Harrop, Head of International Equities

In theory, investing is simple. It is about compounding your returns over time. It's hard to get your head around the fact that a 7% annual return means making 8 times your money over 30 years. Even harder, that 10% means 18 times. Of course, it is much easier said than done, especially when it is a statistical fact that even the world's greatest investors will make plenty of mistakes. Running your winners is therefore extremely important, but so is cutting your losers. Which is one of the reasons LGT Vestra do not believe in simply researching and recommending stocks because they are "in the index". An index is a great snapshot of history at a point in time; it is a terrible predictor of the future. When we are investing your money, we want it to be a privilege for any individual company's shares to be part of your portfolio.

Among the many factors we consider is the governance of a company. For instance, as a minority shareholder, do you have equal rights? While we are big fans of owner-entrepreneurs, we do not believe that means they are first among equals. We read a lot of IPO documents. First day price spikes and the still opaque allocation of IPO stock would take another article to do justice to the reasons why we almost never recommend them. Post-listing, some stocks can be interesting, but mostly the IPO documents provide valuable insight into the zeitgeist.

Snapchat listed in 2017 by selling $3.5bn in stock that has NO voting rights at all.[1] The co-founders would be able to maintain ownership of the company even once they had sold down their stakes substantially, and post death (yes, really). This is not the sole reason we do not recommend the stock – Facebook and Instagram 'sharing' most of its features, showing little moat around the business counts more – but it does not help.

WeWork, the ill-starred, free beer, flexible office space lessor, gave 20 times the voting rights to its (now former) CEO than every other investor.[2] Even the stock market eventually balked at that. Although their selling short-term memberships to buy long-term property leases model might have had more to do with it. (Lehmans/Northern Rock, anyone?). And now, along comes the UK's 'The Hut Group', where the 20% CEO and family stake gives them a voting majority for the next three years… even in the event of his death.[3] I am forced to question: is that really necessary? The winner in terms of poor corporate governance has to be recent big-data-for-spooks provider, Palantir, from over the pond. The capital structure is opaque at best, but appears to give the three co-founders a voting majority irrespective of their underlying ownership. Don't worry though, it's 'only' valid until the youngest of them shuffles off this mortal coil. He is 37.[4]

We are not dogmatic, having recommended Google/Alphabet for years despite the co-founders ruling the voting roost even with only 11% of underlying equity. We would prefer this were not the case, but in the round, transparency of earnings disclosure, the huge moat around the business, and the lack of abuse of their voting rights in the 23 years since listing, have outweighed this for us. Similarly, we are ok with Berkshire Hathaway issuing non-voting stock where holders even need to buy a ticket for the AGM! In the 24 years they have been around, nothing management has done suggests there is more implicit risk in holding the non-voting shares. We are, of course, careful to ensure this remains the case. 

It's not simply coincidence that capitalism includes the word 'capital'. The less that capital is associated with voting rights, the harder it is (or impossible) for shareholders to influence under-performing management. Which in turn makes it harder for Schumpeter's creative destruction to aid capitalism's evolution by natural selection.

"Down with this sort of thing" as Father Ted would protest.

[1] Source: Snapchat S-1 IPO filing

[2] Source: WeWork S-1 IPO filing

[3] Source: The Hut Group S-1 IPO filing

[4] Source: Palantir S-1 IPO filing

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