By ;Palash R. Ghosh: Subscribe to ;Palash's RSS feed
August 11, 2010 3:00 AM EDT
Along with the dodo bird, the Edsel, and the 5-cent cigar, the 'tracking stock' structure that some Wall Street companies once embraced appears to be on the brink of extinction.
Tracking stocks emerged on the landscape back in the 1980s and 1990s when a large corporation sought to unlock the value of one of its high-performing divisions by splitting it off into a separate entity -- shares of the newly-issued tracking stock would mirror the performance of that
particular segment, while the parent company would still have ultimate control of the division. It was viewed as an alternative to the pure spin-off in which the separated company would itself become a completely independent entity.
Under the tracking-stock scheme, the unit's revenues and expenses are separate from those of the parent company's financial statements. If the tracked unit suffers large losses, they are absent from the parent's financial statement; on the other hand, if the tracking stock performs well, the parent can use its shares to make acquisitions instead of cash.
For the holders of tracking stocks, there were some significant disadvantages and risks. For one thing, voting rights were limited with these shares. Moreover, the tracked unit was subject to the same management and board of directors as the parent corporation.
In the event the parent liquidated, after the claims of creditors and preferred shareholders were satisfied, ordinary shareholders had an interest in the remaining assets of the entire conglomerate. Liquidation shares were usually based on the relative market cap of each class of tracking stock immediately prior to liquidation.
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Tracking stocks proliferated during the dot.com boom of the mid-1990s when big corporations sought to maximize the value of their new internet-related subsidiaries, which were expected to deliver huge growth. Perhaps the best known examples were Go.com, created by Walt Disney Co. (NYSE: DIS); and the cellular phone units created by AT&T (NYSE: T) and Sprint, among others.
All have long since vanished.
"Tracking stocks have disappeared probably because they didn't deliver their promise of outsized returns," said Dr. Anna N. Danielova, assistant professor of finance at the DeGroote School of Business, McMaster University in Hamilton, Ontario, Canada. "In many cases, a large conglomerate would create a tracking stock for a division that engaged in a business that was very different from the parent's core operations. It was otherwise difficult for the market to place a value on the wayward unit. Best of all, the parent retained control of the subsidiary without having to relinquish it -- as would happen in a spin-off."
In some cases, a large conglomerate which has numerous disparate subsidiaries under its vast umbrella may have some units which are cash cows, while others are cash-starved, but boast promising projects. The tracking stock structure allowed the parent to use the revenues generated by profitable units to finance the operations of the more cash-poor divisions
Danielova's research reveals that during 1984-2002 -- the heyday of the 'tracking stock era' -- a total of 74 tracking stocks were announced, but about 27 of them never came to see the light of day. This means that at their peak in the mid-1990s, there was no more then 45 to 50 of these tracking shares in existence. Indeed, in 1999-2000 (as the market bubble ascended and popped) many tracking stocks were eliminated.
Of those 74, Danielova estimates that 10 companies introduced tracking stock in conjunction with the acquisition of another firm or a merger, 14 introduced tracking stocks by means of an IPO, while 19 companies likely considered spin-offs, but went ahead with creating tracking stocks instead.
Also, while tracking stocks are normally associated with technology/internet/communication industries, they appeared across a broad array of sectors.
Companies as diverse as General Motors (NYSE: GM), US Steel (NYSE: X), Ralston-Purina, RJR Nabisco Holdings, Fletcher Challenge, Genzyme Corp. (NYSE: GENZ) and K-Mart had established (or planned to establish) tracking stocks.
Media giant Liberty Media Corp. might be the sole publicly traded U.S, corporation that has retained the tracking stock arrangement -- but even this will not last long.
The conglomerate, owned by John Malone, runs three divisions: Liberty Capital (NASDAQ: LCAPA and LCAPB), Liberty Starz (NASDAQ: LSTZA and LSTZB), and Liberty Interactive Group (NASDAQ: LINTA and LINTB), each of which trades as a tracking stock.
The company recently announced plans to simply its extremely complex structure by converting its largest unit, Liberty Interactive, into an asset-backed stock. The parent will subsequently spin off the Liberty Capital and Liberty Starz tracking stocks.
Malone is believed to have kept the tracking stock structure (long after all other such tracking shares have disappeared) primarily for tax benefits.
Anthony L. Alfonso, president of BDO Valuation Advisors in Los Angeles, said that tracking stocks were also a way for corporations to retain their best employees since they could offer stock option plans in the unit's shares.
But given the new reality of a tight job market, most employees now are simply happy to have a job, so there's no need for companies to cook up 'incentives' to keep their people.
In addition, Alfonso notes, the introduction of accounting changes in 2003 which forced companies to recognize stock compensation expenses further diminished the appeal of tracking stocks.
Danielova suggests that another factor in the demise of tracking stocks has to do with their complexity -- many retail investors likely did not understand them.
"In a hot bullish market as we witnessed in the 1990s, investors will buy anything, but in more bearish periods, they likely become more circumspect with their investment decisions," she said,
Danielova does not think tracking stocks will make comeback, unless they appear in some alternate form with a slightly different packaging.
After all, no one has seen a dodo bird lately.
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