Tracking Stocks

When is an initial public offering (IPO) not an IPO? When the stock is issued under the protective wing of its parent company as a tracking stock.

Companies set up a tracking stock by bundling similar businesses and divisions together and filing their plans to sell the stock with the Securities and Exchange Commission (SEC). The SEC then goes through a regulatory approval process similar to that for an IPO.

Tracking stocks differ from regular common stock in a key way: All assets of the business traded as a tracking stock are held by the parent company -- not the shareholders of the tracking stock.

Owners of the tracking stock benefit from the rising per-share prices of the tracking stock. The parent company often retains some shares in the tracking stock.

For example, General Motors Corp. owns 68% of GMH, the tracking stock for its Hughes Electronics Corp. subsidiary in El Segundo, Calif. Revenue from Hughes Electronics rolls into GM's income, which wouldn't happen if GM had spun it off as a separate entity.

Tracking stocks have been around since 1984, when GM issued separate shares of its then-subsidiary Electronic Data Systems Corp. in Plano, Texas.

Last year, there were more than a dozen new or pending tracking stock issues. This year shows no letup, with another four issues already announced.

For example, Framingham, Mass.-based office-supplies distributor Staples Inc. last year filed with the SEC to create a tracking stock for its Internet business, Staples.com. And in January, The New York Times Co. announced it was filing to create a tracking stock for its Internet business, Times Company Digital in New York.

The reasons for setting up a tracking stock haven't changed during the past 17 years, according to Barbara Byrne, managing director at Lehman Brothers Inc. in New York. She was involved in setting up that first tracking stock, GME.

"It gives them another horse to ride in the (stock) market," Byrne says. A company may set up a tracking stock, rather than spinning a unit off into a publicly held company, because it wants that line of business to diversify its core holdings. By maintaining control over the business unit, the shine on that tracking stock's growth reflects back on the parent company, she says.

Byrne says mature companies are realizing they can create value by being involved in the Internet economy through tracking stocks they create from their high-tech businesses. On the other hand, she says, she doesn't think the explosion in dot-com stocks is causing an increase in tracking stocks.

Focused Markets

Hughes Electronics, created by GM in 1985, and Redmond, Wash.-based AT&T Wireless Group., a pending tracking stock created by AT&T Corp., are examples of tracking stocks focused on one area of a company's services.

"It allows us to get some investors that we might not ordinarily have: people not interested in the auto business, but interested in what Hughes is doing," says Richard Dore, director of corporate communications at Hughes Electronics. "The benefit in owning a tracking stock is that it's in an industry you're excited about, it's in a high-growth business, but you don't want to own the parent company." Hughes, which includes DirecTV Inc., satellite and wireless businesses, is seen as a growth stock, while GM is considered more mature and less likely to grow in value quickly, he says.

Creation of the separate publicly traded stock, especially in a growth industry like communications, allows the parent company to distribute greater value to its shareholders through the higher share prices of the growing business unit. At the same time, the parent company can diversify its holdings beyond its own stock, which may be in a mature, undervalued industry, Byrne says.

The parent company can buy other companies using the capital raised by issuing the tracking stock, without raiding its own treasury for cash or selling more shares of its own stock, thus diluting the value of each share. Tracking stocks also give companies a way to create incentives for executives in growing business units. By offering executives options in a tracking stock, the company closely ties the executives' compensation to the performance of the business unit. Byrne describes Burbank, Calif.-based The Walt Disney Co.'s November issuance for Sunnyvale, Calif.-based Go.com as an example of a tracking stock created for this purpose.

Taking Stock

Of the nearly 40 tracking stocks announced since 1984, all but five remain tracking stocks, reflecting their parent corporations' expectations that they may have more potential on Wall Street than the parent company's.

Hughes Electronics, a business unit of General Motors and a GM tracking stock since 1985, is an example. "We believe Hughes is the process by which we're going to introduce advanced communication into automobiles, so it behooves us to continue to hold it as a tracking stock," said Catherine Dunsby, manager of financial communications at GM.

But tax implications, a change in strategic direction or a shift in the business climate can lead a company to spin off a business unit underlying a tracking stock, creating an independent company, Dunsby said. That's what GM did with EDS. It had been a GM tracking stock since 1984, but GM spun it off in June 1996.

When a tracking stock is split off, the parent company offers its shareholders the option of exchanging their stock in the parent for stock in the new company, Dunsby said.

If a company doesn't want to turn the business unit into a separate company, but no longer believes the business unit has value as a tracking stock, it may decide to redeem it by buying back the shares.

Copyright © 2000 IDG Communications, Inc.

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