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Tracking Stock for Utilities: Highway to Higher Valuations?
Telecoms may offer IOUs a model for multiplying market caps by dividing their shareholdings.
April 1, 2000
On Feb. 1, CMS Energy Corp. announced plans for a $600 million initial public offering (IPO) of a "tracking stock" that will represent a 20 percent interest in its electric and natural gas utility subsidiary, Consumers Energy. News of CMS Energy's proposed offering comes at a critical time for the energy industry.
Utility stocks have fallen on hard times and the reason is not hard to uncover. The inexorable march of electric industry restructuring exposes large parts of an integrated utility's operations to the forces of competition. Even as it is being forced to abide by market rules in certain sectors, the utility remains weighed down by regulatory obligations in others. That leaves the utility shareholders confused and its management frustrated.
Previous exercises in deregulation and reform in other industries, most notably telecommunications, similarly have transformed the characteristics and prospects of their incumbent monopolies' constituent businesses. Confronted with apathetic investors, many of these companies have sought to enhance their investment appeal by reengineering their balance sheets and creating "tracking stocks" - separate categories of common stock linked to the performance of their various individual lines of business. Can utilities follow this strategy and increase their market capitalizations by issuing such stocks that independently track their regulated and deregulated businesses? Or will these securities only heighten the tension between a utility's different business groups?
Splitting the Issue: When the Sum of Parts Exceeds the Whole
What are tracking stocks? And how can they "create" shareholder wealth? Also known variously as "letter," "alphabet," or "targeted" stock, a tracking stock is a class of common stock that usually represents an economic, rather than a legal, ownership interest in a discrete set of assets and operations of a diversified company. Shares of a tracking stock are designed to constitute the economic equivalent of an equity stake in a particular line of business, division, or group within the company. A tracking stock structure enables a company to repackage its existing equity securities in a manner that facilitates easier access to multiple sources of capital, each with a different investment objective. By targeting investors whose risk preferences are more closely aligned with the performance characteristics of a company's various individual business groups, a company can use tracking stocks to help lower its cost of raising capital and, as a result, achieve a higher stock market valuation.
Over the years, at least 21 different companies in various industries have issued a total of 50 tracking stock securities. As of the end of 1999, the aggregate capitalized value of outstanding tracking stock issues exceeded $400 billion. Most issuers distributed shares of their new classes of tracking stock as stock dividends to their existing shareholders. However, almost a quarter of all tracking stock issues to date have been IPOs that raised additional capital for the issuing companies.[Fn.1]
Setting the Genco Free. Why might utilities consider adopting tracking stock equity structures? Restructuring of the electricity industry is creating a schism within the integrated utility. The
