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Tracking Stock for Utilities: Highway to Higher Valuations?

Fortnightly Magazine - April 1 2000

Enough?

Tracking stocks are enjoying a surge in popularity as diversified companies of all types use them to obtain higher earnings multiples for their "new-economy" businesses. But are they right for integrated utilities?

Though tracking stock equity structures may work well for some utilities, their costs might prove overwhelming for others. Utilities that are likely to derive maximum benefits from such structures are those with extensive T&D operations, often spanning several jurisdictions, that are also making significant investments in deregulated businesses. Some of these companies may have made strategic decisions to retain their utility operations while simultaneously moving to compete aggressively with independent power producers and merchant plants in the deregulated generation sector. For others, tax-related reasons or impending restructuring in one or more jurisdictions in which they operate may have rendered an immediate divestiture of either their generation or T&D operations impractical.[Fn.14] In both cases, a tracking stock structure at the holding company level could reduce the utility's overall cost of equity capital. A separate stock linked to its utility operations also would enable such a company to reserve the benefits of this business exclusively for a narrowly defined group of shareholders while shielding the rest from regulatory risk. CMS Energy's decision to institute a tracking stock structure reflects both of these motivations.

Electric industry restructuring is requiring utilities to rethink their current business structures and practices. There is no reason why a utility's existing capital structure should be excluded from such a review.

1 "Country Briefing, USA Finance: Tracking-Stocks Experience Revival," CFO Magazine, Nov. 9, 1999.

2 For a detailed discussion of the major securities laws, corporate governance and tax considerations and implications of a tracking stock equity structure for an integrated utility, see Ajay Gupta, "Tracking Generation - Financial Innovation For A Restructuring Industry," The Electricity Journal, May 2000.

3 See U S West Inc., Proxy Statement And Prospectus, Sept. 5, 1995, at 40, 45.

4 Lashinsky, Adam, "Will the Boom In Tracking Stocks Derail Investors?" Fortune, Jan. 10, 2000, 210.

5 See infra note 10 and accompanying text.

6 Mehta, Stephanie, "Global Crossing CEO Quits After A Year In Post," The Wall Street Journal, March 3, 2000, at B8, Col. 1.

7 Kanell , Michael E., "Atlanta Tech: Tracking Stock Might Have Right Ring For BellSouth," The Atlanta Journal and Constitution, Jan. 12, 2000, at 1D.

8 Cantwell, Rebecca, "Split Is Likely To Be A Hit; US West Breakup Turning State's Largest Employer Into Two Pricey Companies," The Denver Rocky Mountain News, May 31, 1998, at 1G.

9 US West itself has agreed to merge with Qwest Communications International. See Henry Goldblatt, "Qwest's Latest Fashion Makeover; Joe Nacchio Creates A Global Telecom Contender," Fortune, Aug. 16, 1999.

10 Goodman, Peter S., "Questions Greet MCI-Sprint Deal; FCC Chief Raises Price Concerns," The Washington Post, Oct. 6, 1999, at A1.

11 See generally Erica H. Steinberger and Jeffrey J. Hass, Introduction to Tracking Stocks, in Acquisitions, Mergers, Spin-Offs, And Other Restructurings, 523 (PLI Corporate Law & Practice Course Handbook Series No. B-825, 1993).

12 Scherreik, Susan, "Tread Carefully When You