What an Alphabet breakup would mean for shareholders

The market up until now has reacted negatively to those rulings. On April 17, as Barron’s reported, a federal judge ruled that “Alphabet’s Google has violated antitrust law through its dominance of two online advertising markets." On that day, the company shed $24 billion in market cap even as the broad stock market rose. That decision came on top of a ruling last August in a separate case, in which the judge ruled that “Google is a monopolist, and it has acted as one to maintain its monopoly." On the day of that ruling, Alphabet shed nearly $85 billion in market cap.

Alphabet has indicated it intends to appeal these decisions. Even if the company ultimately loses, we can only speculate about what the courts might order the company to do. But splitting it up has been widely mentioned as one possible outcome.

Perhaps the closest historical parallel to the prospect of breaking Alphabet into its separate companies is AT&T’s split in the early 1980s into seven so-called Baby Bells. According to a 1993 history of the antitrust case by James B. Stewart, an emeritus Columbia Journalism School professor, the company’s chairman considered the federal government’s antitrust suit against the company as a “national catastrophe."

The company had always assumed that “a fully integrated phone system, including phones, wires and equipment manufacture and research at the renowned Bell Labs, was the efficient way to deliver a national communications system—a ‘natural monopoly’ if there ever was one," Stewart wrote.

In fact, however, the breakup that the federal government imposed was a huge success, as you can see from the accompanying chart. A portfolio of the seven Baby Bells into which AT&T was split significantly outperformed the S&P 500 index over the 15 years after the seven Baby Bell stocks began trading in November 1983. In contrast, IBM, which successfully resisted a parallel effort by the federal government to break it up, was a big laggard over those 15 years.

As Stewart wrote in 1993, “Nearly everyone in the computer industry agrees that, following its antitrust victory, IBM complacently retreated into the mainframe world it dominated—a strategy that was rewarding in the short term but has now proved disastrous." AT&T’s progeny, in contrast, liberated from their inefficient conglomerate structure, could take advantage of the nascent internet and wireless revolutions that were just beginning.

Diversification Discount

Though AT&T and IBM comprise a sample of just two, their contrasting experiences are consistent with a well-known theory in academic finance known as the “diversification discount." According to that theory, the average diversified company’s market value will be less than the sum of its individual parts.

The source of the diversification discount is that, in most cases, the market does a better job than company management in deciding how to allocate capital between its various divisions. One famous study, which appeared two decades ago in the Journal of Finance, found that conglomerates tend to allocate funds toward their most inefficient divisions—and that this tendency becomes more pronounced the more complex and diverse the conglomerate.

A textbook illustration is General Electric, which was one of the largest conglomerates in recent U.S. history. Under the leadership of Jack Welch and Jeffrey Immelt, GE acquired nearly 1,000 companies across many different businesses. Not surprisingly, its stock-market value mushroomed during this frenzy of acquisition, and for several years in the 1990s and early 2000s it had the largest market cap of any U.S. company. From 2004, however, the last year it was ranked first in the market cap rankings, until 2024, when it finally split into three separate companies, GE’s stock lagged behind the S&P 500’s total return by an annualized margin of 2.5% to 9.8%.

Because there are exceptions to the diversification discount, it’s possible that Alphabet can overcome the historical odds against diversified companies. But investors should ask certain questions when assessing the company’s prospects and whether being broken up would be such an awful prospect. The main question: How confident are you that Alphabet’s management knows more than the market in how to allocate capital between the company’s myriad divisions?

Consider the range of business lines pursued by Alphabet’s many divisions. Though the company continues to derive the bulk of its revenue from search engine and YouTube advertising, in recent years it has diversified in many additional directions: Healthcare and disease prevention (its Verily division), urban innovation (Sidewalk Labs), curing death (Calico), an early stage venture firm (GV), a private-equity firm (CapitalG), self-driving cars (Waymo), robotics software (Intrinsic), a commercial drone delivery service (Wing), and airborne wind turbines (Makani)—to name a few.

The company has a complex organizational structure, with some of these divisions organized as separate companies owned by Alphabet’s Google subsidiary, while others are separately owned by the parent company through its “Other Bets" unit.

The broader investment lesson is the need to subject your investment beliefs to scrutiny. This is especially important for those beliefs we think are most obvious, since they are those we otherwise are most likely to accept without question. As illustrated by AT&T’s success after losing its antitrust case, investors who resisted conventional wisdom and stuck with the company through its breakup were eventually quite handsomely rewarded.

Mark Hulbert is a regular contributor to Barron’s. He can be reached at mark@hulbertratings.com.