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Tracking stocks have become a popular way for a company to "spin-off" a separate division. However, issuing tracking stock is not the same as creating a completely independent company with separately traded stock.
Tracking stocks are usually issued by a parent company to create a financial vehicle to track the performance of a particular division or subsidiary. When a parent company issues tracking stock, all revenues and expenses of the division are separated from the parent company's financial statements and attributed to the tracking stock. Often this is done to separate a high growth division with large losses from the financial statements of the parent company.
Unlike common stock, tracking stock is usually not sold into the market, with proceeds going to the division. Generally, tracking stock comes into existence as the result of an acquisition, or a spin-off.
The parent company always has the right to reabsorb the tracking stock into the common stock of the parent, generally in an exchange at a "fair" ratio for the parent common stock.
Once a division has been spun-off into a tracking stock the financials of that division are completely separated from that of the parent, allowing the market to determine the value of the division. Without tracking stock, analysts must make a determination of the value of the division, often without benefit of separate line item financials for the division.
Divisions with tracking stock are different from subsidiaries in their corporate structure. The division does not have a separate board of directors, nor does it have the capability of holding its own shareholder proxies. In addition, the parent company is still legally responsible for the debts and liabilities of the division. A tracking stock division cannot declare bankruptcy separately from its parent company.
Owners of tracking stocks purchase the stock with the sole anticipation of growth. Future acquisition or reabsorption into the parent company is usually the sole anticipation of reward for tracking stocks. Because of the type of division that is spun off into tracking stocks, they usually do not pay dividends.
In the market environment of the late 1990s, high growth companies have been the most valued. When a large profitable company owns a division with high growth potential, the appeal of a tracking stock is that the losses associated with the division can be separated from the earnings history of the parent company. This allows the market to clearly separate the high growth, low profitable business from the slower growth, profitable business. By spinning off the tracking stock into a separate trading entity a new market is created for the stock by investors seeking high growth opportunities.
For practical trading purposes, tracking stocks function exactly like common stock. Your tracking stock may be reabsorbed into the parent, at a value you may or may not be happy with. However, acquisition of this kind would be subject to shareholder vote and is therefore really no different than a merger or acquisition of common stock.
Robert V. Green