A tracking stock is a fairly new type of issue used by
larger companies as a type of "spin-off". A company issues a
tracking stock for one of its business divisions, but the
division is not formally separated from the company. Most
often, tracking stocks are issued by companies that have
sexy divisions expected to achieve high valuations in the
market.
A company will issue a dividend of tracking stock to its
current shareholders. The investors will continue to hold
their original company shares, but they will also own newly
issued tracking shares. This stock will represent the
earnings of the tracking divisions.
Despite having separately traded stock, the tracking
business is not a separate company. From a legal standpoint,
there will still be one company with one board of directors.
When a company issues a tracking stock, it has to prepare
three sets of financial statements (such as balance sheets
and income statements) instead of one. One set will reflect
the company as a whole, as before. A second set will reflect
the business line being tracked. A third will reflect the
company's operations excluding those belonging to the
tracking stock. The company has not really split up, but for
reporting purposes, its assets, expenses, income, and cash
flow are allocated between the company and its tracking
stock.
The company has basically segregated its assets into two
different segments. The company will still be the same large
entity, but its assets will be allocated between original
stock and the tracking stock. The income, expenses, and cash
flow of those two entities will also be segregated.
There are several advantages in the
decision to issue a tracking stock. The appeal of tracking
stocks is that they can help investors see a company's full
value. Consider a telecommunications company, which issued a
tracking stock for its wireless operations. Perhaps this
company thought that investors were just thinking of it as
an old-fashioned giant company. By issuing a tracking stock,
it draws attention to its dynamic wireless operations, and
these operations might be accorded a higher value than if
they remained imbedded in regular company stock. Assuming
this comes to pass, then the higher-valued shares can be
used as currency when the company wants to buy another firm
or forge an alliance.
Other advantages realized by the
company are the ability to allow shareholders to invest
separately in its divisions and better alignment of the
company's incentive stock options for employees. Employees
of the tracking division will be able to participate more
directly in the success (and failures) of that business.
Having a tracking stock will give the company the ability to
better compete for top-notch employees.
Finally, many tracking division
investors may shy away from investing in the company because
right now they have to buy all of the company's other
businesses along with the tracking division. When the
tracking stock is issued, those investors are much more
likely to evaluate the tracking division as an investment
option.
Of course, all of the advantages
just listed could be achieved if the company were to
spin-off its tracking business into a separately traded
company. So what is the advantage of having a tracking stock
over a spin-off? In a word, cash. The tracking segment of
the company is investing lots of cash to grow its business.
At the same time, the other businesses of the company
generate significant cash flow. By maintaining one corporate
structure for both businesses, the tracking division has a
ready provider of debt and equity capital when needed. The
added financial flexibility of a strong capital partner
could become a crucial competitive advantage for the
tracking division.
The biggest drawbacks of a tracking
stock are the lack of a separate board of directors to
oversee the tracking business and the limited voice that
tracking stock shareholders have over the business. The
company will continue to have only one board of directors
responsible for both the core business and tracking
business. Based on the history of other tracking stocks, the
tracking division shareholders will not have a significant
voice in their selection (since the core business will be
much larger, it's shareholders will have a larger voice in
the election). Any situation where directors are not held
directly responsible for their actions via shareholder votes
is a reason for concern.
Historically speaking, tracking
stocks tend to perform just about as well as the company's
underlying business. A complete spin-off of non-core
operations is often preferable to the issuance of a tracking
stock because it allows for a clean break and extremely
focused management. However, a tracking stock can be a more
appealing option under certain circumstances, such as when a
strong balance sheet provides a competitive advantage.