A tracking stock is a type of issue used by larger companies as a
type of "spin-off". A company issues a tracking stock for one of its
business divisions, but the division is not formally separated from the company.
Most often, tracking stocks are issued by companies that have sexy divisions
expected to achieve high valuations in the market.
A company will issue a dividend of tracking stock to its current
shareholders. The investors will continue to hold their original company shares,
but they will also own newly issued tracking shares. This stock will represent
the earnings of the tracking divisions.
Despite having separately traded stock, the tracking business is not a
separate company. From a legal standpoint, there will still be one company with
one board of directors. When a company issues a tracking stock, it has to
prepare three sets of financial statements (such as balance sheets and income
statements) instead of one. One set will reflect the company as a whole, as
before. A second set will reflect the business line being tracked. A third will
reflect the company's operations excluding those belonging to the tracking
stock. The company has not really split up, but for reporting purposes, its
assets, expenses, income, and cash flow are allocated between the company and
its tracking stock.
The company has basically segregated its assets into two different segments.
The company will still be the same large entity, but its assets will be
allocated between original stock and the tracking stock. The income, expenses,
and cash flow of those two entities will also be segregated.
There are several advantages in the decision to issue a tracking stock. The
appeal of tracking stocks is that they can help investors see a company's full
value. Consider a telecommunications company, which issued a tracking stock for
its wireless operations. Perhaps this company thought that investors were just
thinking of it as an old-fashioned giant company. By issuing a tracking stock,
it draws attention to its dynamic wireless operations, and these operations
might be accorded a higher value than if they remained imbedded in regular
company stock. Assuming this comes to pass, then the higher-valued shares can be
used as currency when the company wants to buy another firm or forge an
Other advantages realized by the company are the ability to allow
shareholders to invest separately in its divisions and better alignment of the
company's incentive stock options for employees. Employees of the tracking
division will be able to participate more directly in the success (and failures)
of that business. Having a tracking stock will give the company the ability to
better compete for top-notch employees.
Finally, many tracking division investors may shy away from investing in the
company because right now they have to buy all of the company's other businesses
along with the tracking division. When the tracking stock is issued, those
investors are much more likely to evaluate the tracking division as an
Of course, all of the advantages just listed could be achieved if the company
were to spin-off its tracking business into a separately traded company. So what
is the advantage of having a tracking stock over a spin-off? In a word, cash.
The tracking segment of the company is investing lots of cash to grow its
business. At the same time, the other businesses of the company generate
significant cash flow. By maintaining one corporate structure for both
businesses, the tracking division has a ready provider of debt and equity
capital when needed. The added financial flexibility of a strong capital partner
could become a crucial competitive advantage for the tracking division.
The biggest drawbacks of a tracking stock are the lack of a separate board of
directors to oversee the tracking business and the limited voice that tracking
stock shareholders have over the business. The company will continue to have
only one board of directors responsible for both the core business and tracking
business. Based on the history of other tracking stocks, the tracking division
shareholders will not have a significant voice in their selection (since the
core business will be much larger, it's shareholders will have a larger voice in
the election). Any situation where directors are not held directly responsible
for their actions via shareholder votes is a reason for concern.
Historically speaking, tracking stocks tend to perform just about as well as
the company's underlying business. A complete spin-off of non-core operations is
often preferable to the issuance of a tracking stock because it allows for a
clean break and extremely focused management. However, a tracking stock can be a
more appealing option under certain circumstances, such as when a strong balance
sheet provides a competitive advantage.