S&P shuns Snap over its non­vot­ing shares

L.A. firm’s ex­clu­sion from in­dexes could hurt its stock price.

Los Angeles Times - - BUSINESS - By Ethan Var­ian and Paresh Dave

Join­ing the Stan­dard & Poor’s 500 — an in­dex of the na­tion’s big­gest and most pop­u­lar stocks — has long been an im­por­tant mark of val­i­da­tion for busi­nesses. It signals that a com­pany has as­cended to cor­po­rate Amer­ica's elite and boosts its share price by about 5%.

But the recog­ni­tion won’t be be­stowed on Los An­ge­les’ largest and best-known tech com­pany any­time soon. Snap Inc. and other com­pa­nies that limit share­hold­ers’ vot­ing rights aren’t el­i­gi­ble to be­come new mem­bers of the S&P 500 un­der a rule that went into ef­fect Tues­day.

The Snapchat app maker had irked ma­jor share­holder groups, in­clud­ing the re­tire­ment fund for Cal­i­for­nia teach­ers, by be­com­ing the first-ever com­pany in the U.S. to is­sue only non-votable shares in its ini­tial pub­lic of­fer­ing. The March IPO was a rous­ing fundrais­ing suc­cess for Snap, reap­ing the com­pany and share­hold­ers more than $3 bil­lion.

But not giv­ing com­mon share­hold­ers any say on merg­ers, board-mem­ber se­lec­tion and other is­sues has led to a flurry of ac­tions that fi­nan­cial ex­perts say are de­signed to pun­ish Snap and any firms that fol­low in its foot­steps.

“Go­ing to zero votes” an­gered “just enough peo­ple

that the pen­du­lum is swing­ing,” said Laura Mar­tin, a fi­nan­cial an­a­lyst at Need­ham & Co. who pro­vides rat­ings for me­dia and tech stocks. “In­vestors don’t want to be forced to con­done bad gov­er­nance, and that’s an ar­gu­ment I think the S&P took very se­ri­ously.”

S&P Global said in a state­ment that its rule specif­i­cally bars com­pa­nies with “mul­ti­ple share classes” from its 500, MidCap 400 and Smal­lCap 600 in­dexes. Com­pa­nies typ­i­cally use such a struc­ture to grant key ex­ec­u­tives and in­vestors more votes than other share­hold­ers.

In Snap’s case, the firm’s founders, Chief Ex­ec­u­tive Evan Spiegel and Chief Tech­nol­ogy Of­fi­cer Bobby Mur­phy, con­trol about 90% of the com­pany’s votes be­cause they own shares with the most votes. The re­main­ing votable shares are held by in­vestors, board mem­bers and ex­ec­u­tives.

A hand­ful of com­pa­nies with big­ger mar­ket cap­i­tal­iza­tions than Snap are af­fected by the change too, ac­cord­ing to Fact­Set re­search data. They in­clude me­dia com­pa­nies Altice and Lib­erty Broad­band, busi­ness soft­ware mak­ers Work­day and VMWare and credit card pro­ces­sor First Data.

The new S&P pro­vi­sion adds clar­ity to a now-re­moved cri­te­rion that re­quired mem­bers of its most pop­u­lar in­dex to have “a cor­po­rate gov­er­nance struc­ture con­sis­tent with U.S. prac­tice.”

Ex­ist­ing mem­bers with mul­ti­ple classes of stock, in­clud­ing Face­book and Al­pha­bet, are ex­empted from the rule. Should any ex­ist­ing mem­ber change its struc­ture to is­sue a new class of shares, S&P would take into con­sid­er­a­tion sev­eral fac­tors be­fore de­cid­ing whether to in­clude that new class in its ros­ter.

Get­ting re­buffed by the S&P 500 car­ries more con­se­quence to­day than even a few years ago. An in­creas­ing amount of cash — tril­lions of dol­lars — has been in­vested in funds that match or at least closely fol­low the makeup of the S&P 500. Un­like the Dow Jones in­dus­trial av­er­age or the Nas­daq com­pos­ite, the S&P in­dex is viewed by in­vestors as the best re­flec­tion of how the U.S. stock mar­kets are do­ing.

Big com­pa­nies that aren’t in­cluded will draw less at­ten­tion from stock-pick­ers and an­a­lysts who study stocks, Mar­tin said. Re­searchers have found S&P in­clu­sion usu­ally pushes share prices up sev­eral per­cent­age points

“When any­thing cuts out in­ter­est, it’s go­ing to af­fect the price,” she said. “You’re con­demn­ing your­self to lower val­u­a­tions. It gives [in­vestors] the op­tion to ig­nore you.”

Mark Heb­ner, founder of Irvine money man­ager In­dex Fund Ad­vi­sors, said in­vestors have al­ready fac­tored the con­cern about the lack of vot­ing power into the price of Snap shares. That means the com­pany’s fi­nan­cial per­for­mance would play a big­ger role in how its stock per­forms.

But he has no doubt there’s a mes­sage be­ing sent to a gen­er­a­tion of en­trepreneurs. “It’s telling com­pa­nies we don’t want to be a share­holder when we don’t have a vote,” he said.

Me­dia com­pa­nies such as Vi­a­com have used mul­ti­ple classes of shares to in­su­late them­selves from polti­cally charged in­vestors who might try to ex­ert in­flu­ence over its news busi­nesses or other op­er­a­tions.

Tech firms adopted the struc­ture more re­cently, ar­gu­ing that their young, vi­sion­ary lead­ers had a strong grasp on how to run their com­pa­nies. They wanted to en­sure in­vestors’ short-term whims wouldn’t cause dis­trac­tion. Mul­ti­ple share classes have also made it eas­ier for com­pa­nies to pur­sue ac­qui­si­tions, do­nate shares and make other moves with­out di­lut­ing the power of ex­ist­ing share­hold­ers.

S&P’s se­lec­tion com­mit­tee waits about six months to a year to add newly pub­lic com­pa­nies to its in­dexes, mean­ing Snap could have been el­i­gi­ble as soon as next month. Of course, cri­te­ria about “fi­nan­cial vi­a­bil­ity” may have de­layed Snap’s in­clu­sion be­cause the com­pany isn't close to gen­er­at­ing profit.

Last month, Snap was ex­cluded from the FTSE Rus­sell 3000 in­dex, with the man­ager and op­er­a­tor of the Lon­don Stock Ex­change ex­press­ing sim­i­lar con­cerns about non­vot­ing shares. The move fol­lowed polling in which in­vestors in those funds ex­pressed wor­ries they would be forced to in­di­rectly own Snap shares even though they re­jected the idea of not hav­ing a vote.

A sur­vey also was a key fac­tor in S&P’s de­ci­sion, the com­pany said in a state­ment. An­other in­dex op­er­a­tor, MSCI, has yet to an­nounce a new pol­icy.

The largest in­dex fund man­agers — Van­guard, Black­Rock and State Street Global Ad­vi­sors — have ex­pressed frus­tra­tion with the new strin­gent rules. But bar­ring a ma­jor strat­egy change, they have lit­tle choice but to fol­low what S&P, FTSE Rus­sell and MSCI choose to in­clude in their list­ings.

Snap de­clined to com­ment on its re­la­tion­ship with in­dex providers, who an­a­lysts say dealt a sym­bolic blow to the com­pany.

“Peo­ple as­pire to be in the in­dex with­out ques­tion,” said Scott Kessler of CFRA Re­search. “It’s a badge of honor, a rite of pas­sage. But can­didly, they have big­ger fish to fry at this point.”

Snap’s share price has steeply de­clined since its IPO, in large part be­cause of wor­ries that the com­pany won’t be able to main­tain user growth and gen­er­ate sus­tained prof­its. They fell 57 cents, or 4%, to $13.10 on Tues­day.

How com­pa­nies will ad­just to the push­back against Snap is un­clear. Mar­tin pre­dicted in­vest­ment bankers could de­vise a way for Uber Tech­nolo­gies and other IPO can­di­dates to stream­line into a sin­gle share class while lim­it­ing out­siders’ vot­ing power.

Oth­er­wise, “when Uber be­comes pub­lic, they are go­ing to have to make a hor­ri­ble choice be­tween be­ing in the S&P 500 and los­ing founders’ con­trol,” she said. “The Snapchat over­reach hurt it­self and af­fected ev­ery sub­se­quent founder-con­trolled com­pany.”

That in­cludes meal kit de­liv­ery com­pany Blue Apron Hold­ings Inc., which is­sued dif­fer­ent share classes in its IPO in June. The com­pany didn’t re­spond to a re­quest for com­ment. Its shares — priced at $10 dur­ing the de­but — fell 24 cents, or 3.6%, to $6.37 on Tues­day.

Va­lerie Cavi­ness Euro­pean Pressphoto Agency

S NA P co-founders Bobby Mur­phy, left, and Evan Spiegel, who to­gether con­trol about 90% of the com­pany’s votes, with NYSE Pres­i­dent Tom Far­ley in March.

Bryan R. Smith AFP/Getty Im­ages

TRADERS WORK the f loor of the New York Stock Ex­change dur­ing Snap’s Wall Street de­but in March. Its shares surged more than 40% that day but have steeply de­clined since then. They fell 4% to $13.10 on Tues­day.

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