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Equity Instruments
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Common Stock
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Preferred Stock
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Tracking Stock
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Spin-off
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Partial Spin-off
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Stock Rights
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Stock Classes
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Real Estate Investment Trust
(REIT)
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Tracking Stock
What is a tracking stock? This is a stock
investment where a parent company is raising equity by selling a minority
interest in one of its highly visible divisions to the public. The valuation
ratio of a tracking stock is usually higher then that of the parent company,
in effect advertising to the investment community that the parent has a
prized asset. Additionally, because of the higher valuation of the tracking
stock, it can be used as currency to make acquisitions, further enhancing
the prospects of both companies. The tracking stock can also be offered to
management as a form of sweat equity, as an incentive to conserve cash,
while motivating their employees. The new investors only have an interest in
the public tracking stock.
The board of directors of the parent company usually
governs both companies. In many cases, the shareholders of the tracking
stock have fewer rights than the parent company’s shares, as well as fewer
votes per share. The parent will still control the subsidiary. Additionally,
such administration functions as SEC reporting, taxes, etc. are usually
handled by the parent company. The parent company may cross-collateralize
the debt of the tracking stock, keeping interest expense low, as well as
establish tax-sharing agreements to fully utilize tax benefits.
Tracking stocks normally have high growth potential
and investor appeal, and are issued at high valuations. Parent companies can
take advantage of this appeal, by pushing the negative aspects of growth to
the tracking stock. Often, growth requires up-front cash outflows, initial
losses, as well as higher debt levels and capital needs. These negative
attributes can be transferred to the tracking stock, thereby improving the
fundamentals of the core parent company, sometimes at the expense of the
tracking stock, while also controlling the future profits of the tracking
stock.
An innovative company that uses tracking stocks is
Applera, which has two leading businesses with completely different business
models. The businesses are kept separate and trade on the NYSE as separate
tracking stocks. Applied Biosystems Group (ABI) is a leading medical and
life science instrument manufacturer, while Celera Genomics (CRA), the
second tracking stock, is a research and development drug company. Investors
have the option to invest in the portion of the business that’s of interest
to them.
A common investment strategy is to invest in the
company that ultimately controls the profits of the tracking stock. Most
business professionals tend to keep their most valuable assets, and sell
their least attractive or most overvalued businesses first. This should
translate into a “caution” sign. Since these types of securities are
relatively new to the investment community, exercise prudence when
purchasing them.
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