What is a tracking stock?
A tracking stock is a certain type of stock that is issued by a company to represent a particular segment or division of the business. This specialized equity offering is also known as letter stock and targeted stock. It is a special type of stock that is based on the operations of a defined business within the larger organization.
A tracking stock is issued by a parent company to track the financial performance of a particular segment or division. These stocks trade separately from the parent company’s stock in the open market. Therefore, it is traded at a price related to the operations of the specific division of the company being tracked. A tracking stock is usually issued to separate a high-growth division from its parent company. Though the parent company and its shareholders still have control of this subsidiary’s operations.
A tracking stock operates differently from other types of stocks. It allows larger companies to isolate the financial performance of a higher growth segment, thereby, giving investors the ability to gain exposure to a specific aspect of the business of a larger company (for instance, the mobile division within a large telecommunication provider).
These stocks give investors a chance to value specific aspects of a larger company on different terms and with different price-to-earnings (P/E) multiples. Investors can speculate on particular segments or departments of a company, while the management can retain control of the segments without the need to sell ownership or form a separate legal entity that is spun off to shareholders (which would then need its own management team and board of directors).
In the 1990s, tracking stocks experienced their highest prime. During the dot-com bubble, these stocks were effectively the cause of ambitious management teams striving to cash in on valuation levels that appeared to be hitting new highs on an almost day-to-day basis. Even the stable, old-fashioned blue-chip stocks hopped in on the trend.
How does it work?
As a parent company issues out a tracking stock, all the expenses and revenue of the applicable division are separated from the financial statements of the parent company. Therefore, the long-term performance of the tracking stock is not tied to the financials of the parent company but to the segment or division, it follows.
This means that as far as the division does well financially, the tracking stock will likely appreciate regardless of the parent company performing poorly. On the flip side, if the division performs badly financially, the tracking stock will likely fall regardless of the parent company performing well.
The reason why large companies may issue tracking stocks is to separate a segment that doesn’t really fit with the core business. For example, a large manufacturing firm with a small software development division. Moreso, companies can also issue these stocks to isolate a high-growth division from the larger slower-growth parent. Nevertheless, the parent company and its shareholders will still retain control of the operations of the division.
Tracking stocks are registered on the regulations enforced by the U.S. Securities and Exchange Commission (SEC), similar to common stocks. The issuance and reporting of these stocks are essentially the same as they are for any new common shares. However, companies usually include a separate section for the financials of the underlying division and the tracking stock in their financial reports.
Features of tracking stock
- Tracking stock trades as a separate security
- The holders have limited or no voting rights
- Dividend rights are based on the earnings of the company’s division or segment
- No legal claim in an event of liquidation
- Conversion rights
Companies issue tracking stocks in addition to their traditional common stock. These stocks have certain features such as:
Tracking stock trades as a separate security
The tracking stock tracks or depends on the financial performance of a specific operating division or business unit of a company. Therefore, this stock trades as separate security and doesn’t depend on the operations of the company as a whole. This means that the value of a tracking stock will increase should the unit or division perform well regardless of whether the company as a whole performs poorly. Conversely, the value of a tracking stock will decrease should the unit or division perform poorly regardless of whether the company as a whole performs well.
The holders have limited or no voting rights
Unlike the common stock of the company that has voting rights, the tracking stocks usually have limited or no voting rights.
The holders of tracking stocks have a financial interest only in the business unit or division of the company. Their dividend rights are based on the earnings and performance of the tracked business (i.e the company’s division or segment). This means that if a tracking stock pays dividends, the amounts paid are solely based on the performance of the business unit or division.
However, not all tracking stocks pay dividends. But, for the tracking stocks that pay dividends, the dividend policy which entails how much of the tracked business’s earnings are to be distributed and when to distribute them is subject to the discretion of the issuer’s board of directors.
No legal claim in an event of liquidation
The holders of tracking stocks usually don’t have a legal claim on the assets of the company in the event of a company’s liquidation. This means that tracking stockholders do not have a special right to the tracked assets and share in all of the assets of the issuer.
The liquidation rights are usually based on the relative values of the tracked and total assets at the time of issuance. Though, the liquidation rights are sometimes fixed in proportion to relative market capitalization immediately before liquidation.
The issuers of tracking stocks can convert these stocks. They can generally elect to convert the tracking stock, usually at a premium, into another class of stock depending on certain restrictions. The tracking stock automatically converts to another class of stock in some transactions should the issuer sell the tracked assets. In other circumstances, the conversion of tracking stocks may be one of several options.
List of tracking stocks examples
- Walt Disney Company (1999)
- Applera Corporation (formerly Perkin-Elmer Corporation)- Applied Biosystems Stock and Celera Genomics Stock (1999)
- Sprint- Sprint PCS and FON (1998)
- Liberty Media
- Quantum Corp. (1999)
- AT&T- AT&T Wireless Group Tracking Stock (issued 2000; split-off 2001)
Above is a tracking stock list as real-life examples of tracking stocks which will be discussed below:
Walt Disney Company (1999)
Let’s look at the Walt Disney Company as a tracking stock example. During the dot-com bubble, some firms that predated the bubble such as the Walt Disney Company identified their internet operations as high-growth divisions that would benefit from a tracking stock. This company issued a tracking stock for its internet holdings division, Go.com in 1999.
Go.com’s websites included ABCNews.com, SPN.com, Disney’s Daily Blast, and Disney Online. The tracking stock issued was traded under the ticker symbol GO. However, just as the tech bubble was popping, in January 2001, Disney was forced to close Go.com. The company laid off 100s of staff and retired the tracking stock permanently. Disney retired the tracking stock at around the same time the bubble ended.
Applera Corporation- Applied Biosystems Stock and Celera Genomics Stock (1999)
The Applera Corporation is a study case as one of the examples of tracking stocks. This company was the successor company to what was previously the Life Sciences Division of PerkinElmer Corporation. Applera was not publicly traded but consisted of 2 main groups which are the S&P 500-listed Applera Corp-Applied Biosystems Group and Applera Corp-Celera Corporation Genomics Group. These tracking stocks were publicly traded in the proteomics industrial sector. They were formed in 1999 and shared corporate functions and intellectual property.
The two groups of tracking stocks also shifted products as their separate strategies changed. For example, the marketing and sales of the human genome database which was developed by the Celera Corporation Genomics Group were transferred in 2002, to Applied Biosystems Group. This was transferred to the Applied Biosystems Group because it had a more appropriate sales structure to monetize the database. Therefore, allowing the Celera Corporation Genomics Group to focus on new pharmaceutical initiatives.
Furthermore, the Applied Biosystems Group and Celera Corporation Genomics Group did not have separate boards, so the Applera board had to balance the interests of the separate shareholders. Applera spun off the Celera Corporation Genomics Group in 2008 into an independent company, after which Applera Corporation changed its name to Applied Biosystems. In 2008, a merger between Invitrogen and Applied Biosystems was then finalized, forming Life Technologies. Quest Diagnostics acquired the Celera Corporation Genomics Group in 2011, and Life Technologies was acquired by Thermo Fisher Scientific in 2014.
Sprint- Sprint PCS and FON (1998)
Let’s look at Sprint as one of the tracking stocks examples. This company was one of the most attractive telecommunication companies in the 1990s in the United States. Sprint’s traditional landline businesses were highly profitable and paid rich dividends to its shareholders. The company had a new exciting division that specialized in cell phones.
The internet boom got out of hand and pushed the stock price of sprint higher to the extent that the dividend yield became overwhelming. So, the company discovered that cellular companies were being valued at crazy multiples and decided to divide its common stock into two classes of tracking stock. The tracking stocks were traded under two ticker symbols, FON and PCS.
This looks like a dual-class stock setup, though different from what the classic version of such a capital structure portrays. The cellular business was assigned to PCS, while FON was assigned the classic landline business, and the cash cow gushing money from local and long-distance plans. The shareholders of this telecommunication utility were given one share of PCS for every two shares of FON they held.
The demand for PCS was unbelievable after hitting the market and many employees in the formerly world of switchboards and telephone poles became millionaires, due to the fact that speculators made the price of the tracking stock of the cellular division higher. As the stock price increased, people paid less attention to income statements, balance sheets, and other fundamentals.
Consequentially, when the bottom fell out and the company’s growth couldn’t tally a reasonable dividend-adjusted PEG ratio, the stock of Sprint began to collapse. The stock began to collapse together with other overvalued stocks on the New York Stock Exchange and Nasdaq. As a result of this, the board of directors of the company decided to exercise its authority and reassemble the tracking stocks into a single ticker, FON. The shares of PCS were then exchanged for FON.
Far less common, we can still come across some examples of tracking stocks such as Liberty Media. As of December 2020, this company owned more than 76% of Sirius XM Holdings and has spun off its Sirius ownership into three tracking stocks under the ticker symbols, LSXMB, LSXMA, and LSXMK.
Liberty Entertainment (formerly LMDIA and LMDIB on Nasdaq), Liberty Capital (formerly LCAPA and LCAPB on Nasdaq), and Liberty Starz (formerly LSTZA and LSTZB on Nasdaq) were listed at various times since going public. Nevertheless, on September 25, 2011, Liberty Starz and Liberty Capital could no longer be traded. Therefore, leaving Liberty Interactive and Liberty Media as separate companies.
Literally, no major U.S companies had tracking stocks up until August 9, 2012. when Liberty Interactive issued tracking stock for itself using the symbols LINTA and LINTB and Liberty Ventures (formerly LVNTA and LVNTB on the Nasdaq). Presently, Liberty media has tracking stocks for Liberty Sirius Group (Nasdaq: LSXMB, LSXMA, and LSXMK) and Liberty Braves Group (Nasdaq: BATRK and BATRA and on OTCQB: BATRB).
Quantum Corp. (1999)
Let’s look at Quantum Corp as one of the tracking stock examples. The Quantum Corp company, in 1999, issued tracking stock in 2 subsidiaries: its Hard Disk Drive Group (HDD) and its DLT and Storage Systems Group (DSS). Two years later, in 2001, the company redeemed the HDD tracking stock and sold the Hard Disk Drive business to Maxtor.
Benefits and risks of a tracking stock
Just like every other stock, there are benefits and risks associated with the tracking stock. Let’s look at how investors and companies benefit from tracking stocks as well as the risks associated with them.
Tracking stocks have its benefits and risks for investors. These stocks give investors the opportunity to invest in a particular portion of a much larger business. The appreciation potential of well-established conglomerates is usually limited due to them having multiple divisions across various business lines. So, one of the major benefits of tracking stocks is that they give investors access to only the most promising parts of a company.
Another benefit of tracking stocks for investors is that it allows them to participate in the business segments that best fit their own risk tolerance. However, investors need to be careful of the risks involved in buying a tracking stock, especially when the parent company is not well established or struggling.
One of the risks of tracking stocks for investors is that the holders of tracking stocks usually have limited or no voting rights. The parent company and its shareholders still have control of the tracking segment’s operations. Therefore, creditors would have a claim on the tracking segment’s assets in an event of the parent company declaring bankruptcy, even if the segment was doing well.
Tracking stocks has its benefits and risks for companies. One of the benefits of tracking stocks for companies is that they can raise money from issuing tracking stocks. They can then use the proceeds to pay down debt, invest further in the tracking division, or fund other growth projects.
Moreso, through the associated activity of each tracking stock, companies can assess the interest of an investor in specific segments of the business. For instance, a large-scale telecom giant can decide to use tracking stocks to separate its landline services and its wireless segment. Based on the performance of each of the tracking stocks, the investor interest in each division can be measured.
Another benefit of tracking stocks for companies is that it eliminates the need for management to create a separate business or legal entity for the tracked segment. For instance, in a spinoff situation, a board of directors and management team would be required for the separated segment.
Nevertheless, the drawback of companies issuing out tracking stocks is that the company may be parsing out the best parts of the business. For instance, if the parent company performs badly financially, the high-growth segment associated with the tracking stock won’t be able to help offset this poor performance.
Pros of tracking stocks
- One of the advantages of tracking stocks is that they give investors access to the more promising divisions of a company.
- The upside to tracking stocks is that its performance comes only from the tracked segment and not from the parent company as a whole.
- As companies issue tracking stocks, they generate some capital to pay down debt, invest further in the tracking division, and fund growth.
- One of the disadvantages of tracking stocks is that investors can lose their money on these stocks if the performance of the division is poor regardless of whether the parent company does well.
- The holders of tracking stocks typically have limited or no voting rights.
- A major drawback associated with a tracking stock is that creditors may have a claim on the tracking segment’s assets should the parent company go bankrupt, even if the tracking segment is doing well financially.
Tracking stock vs spin-off
The difference between tracking stock vs spin-off is that a tracking stock is issued by a company to represent a particular segment or division of the business while a spin-off is a new independent company created by a company by selling or distributing new shares of its existing business.
A tracking stock is a specialized equity offering also known as letter stock and targeted stock, while a spinoff is also known as a spinout or starburst. Tracking stock is a special type of stock that is based on the operations of a defined business within the larger organization while the spinoff is a type of divestiture created by a company with expectations that it will be worth more as an independent entity.
Companies create tracking stocks to track the fortunes of one or more of their subsidiaries. We can see tracking stocks as distant cousins to spin-offs. However, it is different from a spin-off. In the case of a spin-off, the division is separated from the parent company and goes public. Spin-offs have complete autonomy financially and managerially from the parent company, unlike the tracking stocks that represent shares that are still joined to the parent company. In the case of tracking stocks, there is no legal separation of assets or liabilities.
Therefore, even though the finances of the tracking stock are reported separately from the parent company, the tracking stock and parent company operate under one management team and one board of directors. The issuance of tracking stocks by companies is to hopefully unlock value in their underlying subsidiary. These stocks provide the issuer with some advantages compared to spin-offs.
What is a tracking stock? A tracking stock is issued by a parent company to track the financial performance of a particular segment or division which trades separately from the parent company’s stock in the open market. Therefore, it is traded at a price related to the operations of the specific division of the company being tracked. A tracking stock is usually issued to separate a high-growth division from its parent company. Though the parent company and its shareholders still have control of the subsidiary’s operations.
These stocks were more frequently used in the late 1990s technology boom than they are now, even though there are still some companies issuing them today. They give investors the opportunity to invest in a particular portion of a much larger business and companies raise money from issuing these stocks. However, as with all forms of investments in the stock market, investors must weigh out all the risks and benefits of tracking stocks before making an investment decision. One of the tricky things about investing in tracking stocks is that investors can lose their money on these stocks if the performance of the division is poor regardless of whether the parent company does well.
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