Shareholder activists, and the institutional investors who are increasingly supporting them, continue to press public company boards to take bold steps to unlock the value contained in their various businesses. While some companies may have assets or business lines ripe for divestiture or spin off, targets of shareholder activism are often resistant to the clarion call to the “pure play” evolution process – and for good reason. For many companies, in particular in the technology, media and telecommunications (TMT) space, maintaining diverse business lines can serve a strategic purpose despite different growth trajectories, profitability and trading multiples. Furthermore, the spin-off/divestiture route may pose other challenges – such as the embryonic nature of a new division, the absence of sufficiently developed operations to be a full-fledged standalone company, adverse tax consequences of a separation or a desire to maintain control – which make a spin-off or divestiture undesirable or untimely.
Tracking stock, which allows a company to issue separately traded classes of stock tied to distinct portions of its business, offers one potential method to bridge the gap between the increasing push for pure play stocks and maintaining the benefits of diverse business units under one corporate parent.
Where did tracking stock come from?
Tracking stock was first introduced by General Motors in the mid 80’s in connection with its acquisitions of Electronic Data Systems and Hughes Electronics, businesses that were clearly distinct from GM’s historic operations. Companies subsequently used tracking stock as a tool to monetize undervalued divisions throughout the 90’s and early 00’s; during this period of popularity, companies across industries issued approximately 40 different classes of tracking stock. These included telecoms (including AT&T and Sprint) utilizing tracking stock for their nascent (and capital intensive) wireless businesses; chemical and pharma companies (including DuPont and Genzyme) introducing tracking stock in respect of their different operating units; and others (including Disney and DLJ) issuing tracking stock in respect of online businesses. The trend lost steam about a decade ago, with a number of examples – particularly those that sought to realize value from first gen internet businesses – suffering significant losses following the bursting of the dot-com bubble.
Notably, Liberty Media has continued to use tracking stocks throughout its long history of complex acquisitions, spin-offs and structuring, most recently splitting its common stock into three new tracking stocks (each with its own high-, low- and no-vote subclasses) to separately track its holdings in the Atlanta Braves, Sirius XM Radio and its other media assets (including its interest in Live Nation Entertainment). Tracking stock also was recently utilized by Fidelity National Financial to separate its title operations from its investment activities, after the latter came under criticism from activists. In a more unique context, in connection with Dell’s pending acquisition of EMC, a portion of the merger consideration to be paid to EMC stockholders will consist of shares that will track a portion of EMC’s ~80% interest in VMWare.
How does tracking stock work?
Tracking stock is a special, separately traded class of common stock for which the return is linked to the financial performance of a discrete “tracked” business or set of businesses. Tracking stock can be structured in a variety of ways, including
(A) a separate class of tracking stock to track all or a portion of the issuer’s interest in the tracked business, in addition to ordinary common stock,
(B) a separate class of tracking stock for each of its different businesses
or (C) some combination of the two.
Whichever construction is employed, the “tracking” function is generally structured by tying dividends payable to holders of tracking stock to the performance of the tracked business(es), and/or rights in respect of the value attributable to the tracked business(es) in the context of a sale or similar exit event.
Tracking stock generally is listed and publicly traded separately from the issuer’s other stock and has its own ticker symbol. Importantly, a class of tracking stock may be followed by a different group of analysts from the rest of the issuer company – thereby facilitating individualized market analysis and valuation. The value attributed to a tracking stock will be based in part on the performance of the tracked business and, as a result, movement in the price of tracking stock may not align with movement in the price of the rest of the issuer company’s stock.
Is tracking stock the right option?
By providing the market with both a better view of and a way of attributing value to, a company’s distinct businesses, separately traded classes of tracking stock may help unlock value and increase an issuer’s overall market capitalization. In particular, tracking stock may help mitigate the impact of earnings dilution resulting from aggregating an issuer’s capital intensive and often not-yet-profitable “growth” businesses with its more mature, already-profitable businesses. Some proponents of tracking stock have described it as serving an incubating function – providing a way to identify, focus attention on and potentially raise capital for a business that is not yet ready to stand on its own. Furthermore, by avoiding or delaying a spin-off of the “growth” businesses, investors are able to own a security that, while appreciating in value in accordance with the specific industry of the tracked business, may enjoy operational and financial synergies and scale advantages associated with a large, established company. The “tracked business” remains controlled and wholly-owned by the issuer company, with holders of tracking stock only having a financial interest, and if structured correctly, the process of putting in place tracking stock can remain tax-free to the issuer and existing shareholders.
Implementing tracking stock is not without challenges, including initial administrative burden in the form of amendments to the issuer’s organizational documents (which generally requires stockholder approval), navigating U.S. tax concerns, as well as an ongoing obligation to provide additional financial and narrative disclosure regarding the tracked business. Depending on the structure contemplated, tracking stock may also raise unique issues relating to governance and conflicts of interest, managing liabilities of an insolvent business line and structuring equity based compensation structures, all of which must be carefully considered with counsel. Critics also maintain that the more complex structure confuses investors, and assert that the shares trade at a discount to reflect the governance and other issues.
Another tool in the kit?
Activists and their institutional investor allies are here to stay and can be expected to continue to push companies, in particular mega-caps, to explore various avenues to provide value to shareholders in the near term. While spin-offs and divestitures may sometimes be the right approach, companies often have valid reasons to avoid or at least delay the spin-off/divestiture process, and should explore other ways to provide value to shareholders. Tracking stock can provide a unique tool to provide this value – and in the right circumstances, particularly when supported by a well articulated strategy advanced by a respected board and management team, may be embraced by investors.