Article on tracking stocks from the WSJ...
Popular Tracking Stocks
Include Some Drawbacks
By ROBERT MCGOUGH and REBECCA BUCKMAN
Staff Reporters of THE WALL STREET JOURNAL
Donaldson, Lufkin & Jenrette wants to do it. So does DuPont. Sprint already did it. AT&T nearly did it twice.
The "it" is hatching "tracking stock," where a parent company issues shares in a subsidiary that often has a very different business from the parent.
In recent years, a dozen or so tracking stocks have been issued with a current market capitalization of more than $50 billion. Counting the parent-company stocks (which technically become tracking stocks as well), the total market value is close to $400 billion, according to Lehman Brothers.
To understand why corporate America has embraced the trend, think of unmarried cohabitation: Sometimes two people in a single household can improve their finances by not getting married. It's similar for companies issuing tracking stock.
And for investors, the arrangements at times can work out pretty well, too.
The latest to jump on the tracking bandwagon: DLJ, which proposed in a regulatory filing Wednesday to sell tracking stock for its online-trading subsidiary, DLJdirect, under the symbol DIR. As in most tracking stocks, investors in DLJdirect will have rights to the subsidiary's earnings.
But there's a catch: Investors in DLJdirect won't have a claim on the subsidiary's assets, which will continue to be owned by Donaldson Lufkin. This could be an issue in a takeover because if the subsidiary's assets are bought, the parent gets the premium -- not the investors.
Because DIR stock will reflect DLJdirect's earnings, it should trade in line with DLJdirect's business prospects. Donaldson Lufkin clearly hopes that the aura of the Internet will give DLJdirect the kind of astronomical price-earnings multiple that other online-trading firms get nowadays. The proceeds from the sale of the tracking stock, projected to be $138 million, will go to DLJdirect, and not to the parent company.
Tracking stocks, like cohabitation, have an unseemly air to traditionalists. Not getting an ownership stake in the subsidiary is kind of unsettling, like not getting a marriage certificate. What if things go wrong? How do the furniture and factories get divided up?
"I personally don't like them myself," says Robert Sanborn, manager of the $7.3 billion Oakmark Fund. "It isn't ownership."
But some tracking stocks have been great performers, including Liberty Media, a stock that Mr. Sanborn did buy for his fund. Liberty Media had a total return (stock price change plus reinvested dividends) of 345% in the three years through Wednesday, compared with 104% for the Standard & Poor's 500 Index, according to data from Morningstar Inc. Liberty was initially a tracking stock of Tele-Communications Inc., but now it's a tracking stock of AT&T, which acquired Tele-Communications.
Of course, some tracking stocks have performed poorly, reflecting their underlying businesses. In the same three-year period, the stock of Timber Group, a tracking stock affiliated with Georgia-Pacific, declined 23%.
Bill Nygren, another Oakmark fund manager, doesn't blush at owning tracking stocks. Analysts used to apply a discount of 10% to 15% to the price of tracking stocks such as Liberty Media. "As the years have gone by, people have become more comfortable with why tracking makes sense, and the discount has disappeared."
The downside? It's a more complicated corporate structure, which can be offputting to investors. And potential return is limited because you're not going to get a takeover premium. Still, avoiding tracking stocks out of principle would have kept you out of Sprint PCS Group, which gained about 180% from the closing on Nov. 17, its first day of trading.
DLJdirect is in some ways like most tracking stocks, and it differs in others. One big point of difference: The holders won't have any voting rights at all, according to the prospectus. That's unusual, says Barbara Byrne, a banker and managing director at Lehman Brothers who has studied tracking stocks extensively.
"What they probably don't want to do is lose control of the business," she says, adding that the lack of rights probably won't affect the new stock's value. In many instances, tracking stock holders can't vote for the board of the subsidiary, but can elect directors in the parent.
And because DLJ isn't spinning off part of DLJdirect in a traditional IPO, DLJ can use its hefty asset base to build "both businesses, rather than having to separate them," says J. Stuart Francis, a managing director and co-head of Lehman's technology banking group in San Francisco.
"The beauty of tracking stock is that it allows one balance sheet to support two separate income statements." DLJdirect could pay a lower interest rate on borrowed money because of its parent's resources, but it still can raise equity cheaply -- that is, at a high multiple of earnings -- through its separately traded stock.
Ms. Byrne says many big companies issue tracking stock these days to quickly expand higher-growth businesses that may not have steady earnings -- or any profits at all. Sprint's wireless unit, for instance, doesn't yet make money.
By retaining a share of these hot new businesses, the parent companies benefit as well. And by consolidating the earnings for tax purposes, the parent company may reduce its tax bill.
DuPont said recently it wants to issue a tracking stock for its life-science business. And AT&T considered launching a tracking stock for Tele-Communications.
Look for a rush of new tracking stocks in coming months. That's because the Treasury Department has proposed to tax companies on their gain if they sell tracking stock. Robert Willens, a tax specialist at Lehman, thinks the legislation would apply only to transactions entered into after the law was passed -- which would be in autumn, he believes, if it passes at all. |
