With the recent rebirth of proposed tracking stock issuances (i.e. AT&T’s), let’s take a look at what a tracking stock is and why companies issue them:
What is It?
Essentially a tracking stock is nothing more than a stock that the company who issues it HOPES will be viewed by the market as its own company to command its own valuation. Unlike a full spin-off to investors, the company which is being ‘tracked’ is oftentimes controlled by the mother company’s board and senior management, and is 100% owned by the mother unless a portion was sold to the public in an IPO. The mother company’s intention is to show operations of another part of its company distinct from its main operation in an effort to make a company’s various operating units easier to value.
For example, AT&T ‘made believe’ that its AT&T Wireless was its own company and separated it out from AT&T for reporting purposes. With or without the tracking stock, AT&T will look the same in terms of its income statement and balance sheet because technically all of the Wireless company’s profit/loss flows back through AT&T, as it would even if the Wireless tracking stock did not exist. The intention, however, using this example, is that because wireless stocks generally command a higher multiple (i.e. premium valuation) than long distance providers, AT&T could separate the wireless out and show the market how Wireless is doing as a standalone, with the intention of having that part of the business rewarded as such.
How Does it Benefit the Mother Company?
Developing a tracking stock to represent an arm of the parent company has several implications:
For example, if the tracking entity gets valued as the mother company intends, those shares can be used for acquisitions. Continuing with the AT&T Wireless example, let’s assume they approach a small niche wireless player for an acquisition. The small wireless company might want to sell, but may be reluctant to accept AT&T shares as currency for fear AT&T is viewed too much as a stodgy long distance company and may not realize much value for them and their hard work building their small wireless franchise. However, if AT&T can offer AT&T Wireless shares which will be viewed in the market place on their own, the small wireless company may be now willing to sell and the Wireless unit now has a currency to pay for acquisitions.
Secondly, the availability of shares in the tracked unit can also serve as currency for stock options to reward and/or attract employees. The last thing an employee wants is to get options on a company suffering from something they have nothing to do with and to have their hard work masked by the operations of the mother company. Using our example, AT&T could offer options to its wireless staff in shares of AT&T Wireless, rather than the AT&T shares.
What’s The Value?
So, this begs the question is it a phantom stock? The answer, in typical finance speak, is Yes and No! It is a phantom in that you are not receiving any economic interest in the tracking entity because technically all the money it makes, or doesn’t make, goes back to the mother. So, unlike buying a typical stock, you do not own the company represented by the tracking stock, the mother still owns 100%—technically.
BUT, on the other hand, you can look at it like the parent company believes its other operations are not being valued appropriately, so by separating out a division and allowing it be valued distinctly, the intention is the true value can be recognized as the sum of the market values of the parent company and the tracking unit. This is the definition of unlocking value. Continuing on our example, Wireless and AT&T are really one company, so as one (i.e. AT&T) AT&T felt it was UNDERVALUED because the market was ignoring the wireless unit and just valuing AT&T as a long distance company, but combining the market value of Wireless tracking stock with AT&T might be more representative of the true value of AT&T.
Unfortunately, the market and investors have become so impatient in recent years and demand value now. Management is often forced to make dramatic decisions without regard for the company’s own benefit. Tracking stocks are often contemplated as an effort to “add value”, but often take their effect initially, upon announcement, and then lose their luster. In fact, of the 30 or so tracking stocks now in the market, very few are living up to the expectations of the parent. The intentions are usually very grand, but in many instances, the benefits to the everyday investor are often few and far between, or simply never realized. If you are interested in a tracking stock, be sure to consider each individual stock on its own merits, and don’t necessarily assume one company’s method of issuing a tracking stock applies across the board.