|
Focus Prof. Ian Giddy, New York University Tracking StockShares issued by a company which pay a dividend determined by the performance of a specific portion of the whole company. It is generally a class or series of common stock of the issuing corporation. Tracking stock does not represent or require any change in business structure. Holders of tracking stock are considered to hold equity in the parent company and not the specific entity represented by the tracking stock. Payment is subject to the risk of the operations of the issuer as a whole. Tracking stock is often set up by companies that have several diverse divisions, both so that investors can take a share in a division of their interest, and so that the performance of these divisions can be tracked in terms of shareholder interest. A company will sometimes issue a tracking stock when it has a very successful division that it feels is underappreciated by the market and not fully reflected in the company's stock price..
Salient Features of
Tracking Stock
1. Voting Rights
Holders of tracking stock typically have voting rights, which may be fixed at the time of issuance or floating ( e.g., fixed but subject to periodic adjustments based on relative market values).
2. Dividend Rights
The dividend rights of tracking stock are based on the earnings of the tracked business. The dividend policy ( i.e., when and how much of the tracked business’ earnings are to be distributed) is subject to the discretion of the Board of Directors of the issuer.
3. Liquidation Rights
Holders of tracking stock do not have a special right to the tracked assets and share in all of the issuer’s assets. Liquidation rights are often based on the relative values of the tracked and total assets at the time of issuance, but are sometimes fixed in proportion to relative market capitalization immediately prior to liquidation.
4. Conversion Rights
The issuer can generally elect to convert the tracking stock, often at a premium, into another class of stock subject to certain restrictions. In some transactions, the tracking stock automatically converts to another class of stock if the issuer sells the tracked assets. In other instances, conversion may be one of several options. Alternatives to Tracking Stock
1. Spinoff
The “tracked” assets of the parent are dropped into a new subsidiary, which is then spun off to shareholders of the issuer.
2. IPO Carve Out
The “tracked” assets are dropped into a subsidiary and the subsidiary engages in an initial public offering for up to 20% of its stock. The parent and the new subsidiary remain consolidated for tax purposes.
3. Convertible Debt
Issuer issues debt, which is convertible into stock of the subsidiary. Examples of Transactions
1. Sprint – Sprint PCS (1998)
2. AT&T – TCI and Liberty Media (issued 1999; Liberty
Media split-off planned 2001); AT&T Wireless Group Tracking Stock (issued
2000; split-off 2001)
3. Genzyme Corp. – Genzyme Surgical Products Division
(GZSP) Stock (1999)
4. Applera Corporation (formerly Perkin-Elmer Corporation)
– PE Biosystems Stock and Celera Genomics Stock (1999)
5. WorldCom, Inc. – MCI group stock (2001)
6. Cablevision – Rainbow Media Group (2001)
7. Sony – Sony Communications Network (2001) Sprint Shows Pitfalls of Investing in Tracking Stocks Wall Street Journal; New York, N.Y.; Mar 7, 2003; By Jesse Drucker; Abstract: Some analysts say Sprint's intracompany transactions and allocation decisions have had the effect of bolstering FON, where revenue is on the decline. And, to a greater degree than with some other tracking stocks, one part of Sprint relies on business from the other. Revenue from PCS accounted for roughly $670 million of FON's $15.2 billion in 2002 net operating revenue. As it turns out, Sprint executives and board members collectively own more shares and options in FON than they do in PCS, presenting the potential conflict of interest. To see how the results of one group affect the other, consider how Sprint treats more than $16 billion of debt racked up for its wireless operations. That debt actually boosts FON's results, because the company allocates an interest rate to PCS based on the rate it says PCS would obtain without Sprint's guarantees. The company then counts the difference between the rate charged to PCS and Sprint's actual interest rate as nonoperating income for FON. Such income for FON has risen over the years, to $336 million last year, or 23% of FON's pretax income from continuing operations. Then there are the business relationships between the two companies. Sprint says PCS paid FON $672 million last year for various services, including long distance, making it one of FON's biggest long-distance customers. Indeed, PCS is required to purchase its long-distance service from FON. In contrast to the rest of FON, where revenue has been declining, FON revenue from PCS has more than doubled since 1999. Full Text: Copyright Dow Jones & Company Inc Mar 7, 2003 ASK A ROOMFUL of investors these days to applaud if they like "tracking" stocks, and you probably could hear a pin drop. Look at Sprint Corp. to understand why. Sprint may promise crystal-clear service for its customers. But deciphering Sprint's financial health can be complicated for shareholders, thanks to an increasingly rare stock structure that also raises potential conflict-of-interest issues. Those issues result from the peculiarities of Sprint's two tracking stocks. A Wall Street creation whose popularity surged during the late 1990s, tracking stocks are less prevalent nowadays. At Sprint, one stock tracks the performance of the traditional business, called FON Group, and the other its wireless business, PCS Group. (Both stocks trade on the New York Stock Exchange.) As with other tracking stocks, each of the pair reflects the financial performance of particular parts of the company, not the whole business, and the performances are determined by how the company's executives, backed by a single board, allocate costs and revenue. Some analysts say Sprint's intracompany transactions and allocation decisions have had the effect of bolstering FON, where revenue is on the decline. And, to a greater degree than with some other tracking stocks, one part of Sprint relies on business from the other. Revenue from PCS accounted for roughly $670 million of FON's $15.2 billion in 2002 net operating revenue. As it turns out, Sprint executives and board members collectively own more shares and options in FON than they do in PCS, presenting the potential conflict of interest. Sprint stands by its allocation and spending decisions, which it says are appropriate. But like some other companies with tracking stocks, it acknowledges the potential for conflict. In regulatory filings, the nation's No. 4 long-distance and wireless company says Sprint directors' heavier "economic interest" in FON "could give rise to claims of conflict of interest when our board of directors makes decisions on matters where the interests of the FON Group and the PCS Group diverge." In a separate filing, the company says its directors, including two Sprint executives, owned 15,821,704 million FON shares -- including shares covered by exercisable options -- and 8,395,161 million shares of PCS at of the end of 2001, the latest figures available. At General Motors Corp., where a tracking stock reflects the business of unit Hughes Electronics Corp., regulatory filings note that the existence of the two classes of common stock can lead to "diverging interests" among the holders of the two different stocks. Both Sprint and GM, among other companies with tracking stocks, say they monitor and resolve such potential conflicts through a special board committee. Sprint says its committee ensures that any "potentially divergent interests" between FON and PCS shareholders will be resolved "in the best interests of Sprint and all of its common stockholders." However, some corporate-governance specialists question how it is possible to simultaneously satisfy two sets of shareholders. "You can't maximize one without the other suffering to some degree," says Jeffrey Haas, a professor of securities law at New York Law School. Of tracking stocks generally, he says, "These are the ultimate `trust us' securities at a time when nobody's trusting anybody." Over the past two years, PCS's stock is down 83%, more than the decline of its peer group, while FON's 44% decline isn't quite as bad as its peers. Generally, tracking stocks have underperformed peers, say University of Iowa business school professors Matthew T. Billett and Anand M. Vijh. The potential conflicts at Sprint take on new life in the wake of controversy about executives' use of personal tax shelters sold by the company's outside auditor, Ernst & Young LLP. The shelters have prompted questions about the auditing firm's independence, which serves as a safety net for tracking-stock investors by giving comfort that management's decisions are fair. E&Y and Sprint maintain the independence hasn't been hurt. To see how the results of one group affect the other, consider how Sprint treats more than $16 billion of debt racked up for its wireless operations. That debt actually boosts FON's results, because the company allocates an interest rate to PCS based on the rate it says PCS would obtain without Sprint's guarantees. The company then counts the difference between the rate charged to PCS and Sprint's actual interest rate as nonoperating income for FON. Such income for FON has risen over the years, to $336 million last year, or 23% of FON's pretax income from continuing operations. Of course, that "intergroup interest" doesn't really exist for Sprint Corp. The income is canceled out on a consolidated basis, because it counts as an expense on PCS's income statement. Meanwhile, the "interest" paid by PCS to FON doesn't necessarily hurt PCS's image on Wall Street. Stock analysts tend to judge wireless carriers based on a measurement -- earnings before interest, taxes, depreciation and amortization -- that ignores interest expense. "One of the problems with trackers is that the financials are not clean; a lot of it is hypothetical," says Mark Minichiello, a principal at Spin-Off Advisors LLC in Chicago. Sprint acknowledges that, if FON were a stand-alone company, the $336 million in interest income "would not be there," according to Controller John Meyer. "But, the facts are; FON is part of a tracking stock structure, the intergroup relationship does exist and the activity is fully disclosed. You can't leap to the conclusion that this credit is inappropriate because it would not exist if our corporate structure was somehow different." He adds: "The FON Group has effectively lent some of its borrowing capacity to the PCS Group and the FON Group should be compensated for that. Given the unique aspects of this intergroup activity, we wanted the intergroup charge and credit to appear separately for the shareholders to see." Then there are the business relationships between the two companies. Sprint says PCS paid FON $672 million last year for various services, including long distance, making it one of FON's biggest long-distance customers. Indeed, PCS is required to purchase its long-distance service from FON. In contrast to the rest of FON, where revenue has been declining, FON revenue from PCS has more than doubled since 1999. "I can't speculate what the [FON long-distance] business would look like if we didn't have PCS," says Mr. Meyer. "But, I am sure [it] would be going after its share of the wireless long-distance market." One area where allocation works in PCS's favor is taxes. The company calculates taxes on a consolidated basis, but also calculates taxes excluding PCS. Last year, it attributed a sizable tax benefit to PCS. Meanwhile, FON paid PCS $20 million in 2001 for access to its network and other services. And FON still bears the majority of administrative and general costs, although PCS's share has grown, from 8% in 1999 to 31% in the third quarter of 2002. A Sprint spokesman says that, in matters where the two groups' interests diverge, "the board resolves them by requiring the groups to relate to each other on an arm's length basis. In short, we resolve divergent interests in such a way that neither group subsidizes the other." Yeah, right. |