More ‘Tracking Stocks’ on the Horizon
“Wall Street doesn’t understand me.”
It may sound like a line overheard in a financial-district cocktail lounge, but that’s actually the rationale that some corporations use when creating a “tracking stock.”
With the Internet blossoming as one of the greatest wealth engines in market history, a number of companies, including Microsoft, Walt Disney and Chase Manhattan, are considering launching tracking stocks to raise the value and profile of their online operations.
Tracking stocks, often frowned on by corporate-governance critics and academics, are designed to let publicly traded firms have their cake and eat it too.
A company creates a tracking stock to track the performance of one of its divisions--typically one that is in a line of business that is faster-growing and commands a higher industry price-to-earnings ratio than the parent’s main business.
Unlike in a formal spinoff, however, the parent retains control over the unit even if shares are sold to the public in an initial public offering or distributed to the parent company’s shareholders.
A single board of directors usually presides over the parent and the tracking unit--which critics say leads to conflicts of interest when capital or opportunities must be divided among the parent’s units.
“The best solution is a spinoff,” said Steven Kaplan, a finance professor at the University of Chicago business school. “That way, each company has its own focus, with no conflicts, no cross-subsidization and incentives based purely on each company’s stock performance.”
The use of tracking stocks dates to 1984, when General Motors created a new “E” series stock to track its Electronic Data Systems unit, since spun off. GM did the same thing a year later with its Hughes Electronics unit, which still trades as a tracking stock.
GM’s reason for not immediately spinning off EDS or Hughes was that the smaller units could benefit from cheaper borrowing costs and other financial advantages that came with GM’s enormous size.
Today, companies considering tracking shares may contend that Wall Street looks at them and sees a staid or even boring bank, publishing house or brokerage, failing to appreciate the dazzling “dot-com” unit that lurks within.
“Every corporation in America is going to try to figure out a way to do an Internet play,” said Seattle money manager William A. Fleckenstein, an outspoken market bear.
Fleckenstein, who thinks the Internet boom is the clearest sign that the market is in the grip of a mania, said attempts to capitalize on a sector that is already overheated could easily backfire.
Yet many companies are confident enough in the Internet’s future that they believe tracking stocks are a good way to cash in.
Ziff-Davis Inc., for example, publisher of PC Magazine, Mac World and other magazines, created a tracking stock earlier this year for its ZDNet online publications and Web sites unit.
Quantum Corp., a maker of computer storage devices, broke itself into two stocks, Quantum-DLT & Storage Systems and Quantum-Hard Disk Drive, to highlight the sexier DLT digital-tape business, which serves the Net explosion.
It’s probably too early to tell whether the Net-related tracking stocks will be successful for investors. But the track record for earlier, non-Net tracking stocks has been mixed at best.
One of the starkest contrasts is between Circuit City Stores Inc.’s Circuit City Group and CarMax Group. The former, the consumer-electronics retailer, has surged nearly 81% year-to-date. But CarMax, a seller of used cars, has been a dud, falling 50%.
Still, some companies feel that a tracking stock can solve problems related to executive compensation. A bank, for example, might have trouble finding a Web site designer who would work at a lending officer’s salary, without stock options.
The tracking stock is a means of creating “currency” to attract employees who demand--and get--stock options from Internet start-ups. Such shares might also be used for acquisitions by the unit.
Those were among the reasons that officers of Chase, the second-largest U.S. bank, cited last week in telling employees that the company might sell shares of its Chase.com unit. (A Chase spokesman said Monday that an outright spinoff, in which an entirely separate company is created, is also an option.)
Not all of the recent tracking-stock deals are Net-related.
PE Corp. (formerly Perkin-Elmer) used the format to draw a line between its established, profitable PE Biosystems Group and its money-losing but high-potential Celera Genomics unit.
Analyst Eric T. Schmidt of SG Cowen & Co., who rates PE Biosystems a “strong buy” and PE Celera a “buy,” said the move put the two businesses in sharper focus, helping analysts and investors alike understand the company better.
He gives last April’s tracking-stock transaction itself a big share of the credit for the fact that the market capitalization of the combined company has since zoomed to $9.2 billion from $6.4 billion.
A spinoff of one of the units would not have been preferable, according to Schmidt, because one of the firms would have lost the benefit of PE’s top managers, who oversee both sides. Also, the whole company would have lost the tax write-offs generated by Celera’s losses, he said.
But other experts say such issues can be just as good an argument against the tracking-stock format.
If, say, a fast-growing but unprofitable Internet unit is providing tax breaks for its parent, doesn’t that give the parent an incentive to make sure that the operation never makes money? That might benefit the firm as a whole, but what about investors who own only the tracking stock?
Jeffrey Haas, a New York Law School professor who studies tracking stocks, said such conflicts of interest abound, and investors should be aware of the risks.
Tracking stocks often are just separate classes of parent-company stock, Haas noted. An investor in a tracking stock may have no independent claim on the unit’s assets nor any direct say in parent-company decisions affecting the unit.
Also, if there is a downturn and one of the units struggles or even goes into bankruptcy, investors should be aware that their tracking stock in a healthy unit is not immune to trouble.
Like Kaplan, Haas said formal spinoffs are generally preferable for investors. He noted, however, that companies sometimes avoid spinoffs because they can trigger large tax liabilities. A company with an Internet unit less than 5 years old might have difficulty structuring a tax-free spinoff, he said.
Another option, which avoids some of the conflicts of tracking stocks but falls short of a complete spinoff, is a “carve out,” in which a firm turns a subsidiary into an independent company with separately traded shares, but retains a minority stake.
Bookseller Barnes & Noble Inc., for example, carved out its Internet business, Barnesandnoble.com Inc., in an IPO last May but kept a 20% stake. As a major shareholder, the former parent still has a big say in the online firm, but there is less chance of conflict of interest, or confusion among shareholders.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Tracking the Trackers
Here’s a look at performance this year of “tracking” stocks and, where applicable, of their parent companies’ shares.
*--*
Parent and/or 52-week Mon. YTD tracking stocks high-low close change* AT&T; (T) $64.06-$40.06 $46.00 -9.0% --AT&T; Liberty Media (LMG/A) 41.88-18.94 41.56 +80.5 Circuit City (CC) 52.94-16.88 45.13 +80.7 --CarMax (KMX) 7.13-1.75 2.69 -50.0 Donaldson Lufkin & Jenrette (DLJ) 100.75-32.75 53.69 +31.0 --DLJ Direct (DIR) 45.63-12.56 19.50 +21.8 General Motors (GM) 94.88-59.75 72.31 +22.2 --GM Hughes (GMH) 88.00-33.63 81.81 +106.1 Georgia-Pacific (GP) 54.13-25.31 43.13 +47.3 --G-P Timber Group (TGP) 27.19-19.88 24.00 +0.8 PE Corp. --PE Biosystems (PEB) 78.25-41.94 79.19 +62.3 --PE Celera Genomics (CRA) 53.81-14.19 42.63 +70.5 Quantum Corp. --Quantum DLT/Storage Systems (DSS) 22.25-10.63 16.25 -15.1 --Quantum Hard Disk Drive (HDD) 9.19-5.50 7.13 +5.6 Sprint (FON) 75.06-35.81 73.69 +75.2 --Sprint PCS (PCS) 84.88-12.75 86.31 +273.2 USX (X) 34.19-21.75 24.94 +8.4 --Marathon Oil (MRO) 33.88-19.63 29.38 -2.5 Ziff-Davis (ZD) 29.00-8.44 17.13 +8.3 --ZDNet (ZDZ) 55.50-13.38 20.13 +5.9
*--*
* If stock began trading in 1999, change is measured from initial offering price or close on first trading day (in the case of distributions).
Note: 52-week high prices don’t include Monday’s trading.
Sources: New York Stock Exchange, Bloomberg News
