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Tracking Stock for Utilities: Highway to Higher Valuations?

Fortnightly Magazine - April 1 2000

its assets and operations as well as those whose exclusive interest is either the target's generation or its T&D operations. Transparent prices for tracking stocks will help establish market values for each business and ease the due diligence process. An acquirer that seeks only the target's generation business could exchange its own shares for the utility's generation tracking stock in a tax-free stock swap and "adopt" the target's T&D tracking stock by classifying it as its own tracking stock. An acquirer interested only in the T&D business would do the reverse - swap its shares for the target's T&D tracking stock and assume ownership of the target's generation tracking stock as its own after the acquisition.

Swapping Shares. The telecommunications industry again provides an example of structuring such a transaction. MCI WorldCom's recently announced bid to acquire Sprint highlights the benefits of a target's tracking stock capital structure in forging a deal. Under the terms of the acquisition, holders of Sprint's Class A Common Stock will receive $76 worth of MCI WorldCom stock for each Class A Common Stock share they own. For the separate Sprint PCS tracking stock, MCI WorldCom will issue a new tracking stock, swapping one new share for one old share. In addition, owners of the tracking stock will get a bonus of approximately $11 worth of MCI WorldCom common stock for each share they own.[Fn.10] Separate stocks linked to the FON Group and the PCS Group make it easier for MCI WorldCom to retain or divest either group after completing the acquisition.


A Hesitant Start - But now a rapidly growing list of issuers.

Tracking stocks reflect Wall Street's preference for pure play investment opportunities. A tracking stock is linked to a specific business group within a company by means of independent financial reporting. But legally, a tracking stock is little different from conventional common stock. Shares of a class of tracking stock, like those of conventional common stock, represent a residual claim on the assets of the company that remain after satisfying creditors of all business groups. A tracking stock does not confer a prior right to the assets of the specific business group that the stock tracks. However, shares of the tracking stock trade based on the earnings of this tracked business group. Separate financial statements for a company's different business groups enable investors and business analysts to independently price the specific class of tracking stock linked to each. In essence, tracking stocks work because the financial community believes in the concept.

"What's Good for GM..." General Motors was the pioneer in adopting a tracking stock capital structure. Calling it "alphabet" or "letter" stock, General Motors issued its GM Class E Common Stock to purchase Electronic Data Systems from Texas entrepreneur Ross Perot in 1984. General Motors relied on another letter of the alphabet when it acquired Hughes Aircraft in October 1985 in exchange for its newly issued Class H shares.

Main Street on Target. The term "target stock" was coined by Lehman Brothers when it advised USX Corp. in May 1991 on issuing