Track Record

You’d be feeling pretty flush right now if you had bought into one of last year’s larger public offerings, a hot cell-phone company that first traded on February 5, 1999, at a little over $28. Within a year, the firm’s shares split two-for-one and were trading north of $50 – a nearly 300 percent gain – despite almost $2 billion worth of red ink and similar losses expected in 2000. New stock, incredible valuation, and large losses – it’s a classic New Economy success story.

Only this particular New Economy offering has an Old Economy lineage: The stock is PCS, the wireless subsidiary of Sprint, a 100-year-old company with a more reasonable valuation and profits as substantial as PCS’s losses. Though its roots are in the staid dime-a-minute world of long distance, Sprint’s decision to issue stock in its wireless business reflects the latest trend in digital-age corporate finance. By issuing a “tracking stock” – a seldom-seen but suddenly popular financial instrument that enables corporations to cosmetically distinguish one of their growth divisions in order to let the market trade it separately – Sprint raised more than $600 million and generated a sizable bonus for Sprint shareholders, who were distributed shares of PCS.

Until last year, corporate America squeezed out only one or two tracking deals a year. Then, in 1999, there were eleven. And the pace is picking up. Next month, AT&T shareholders will vote on creating a tracking stock for their wireless business; if approved (and given PCS’s performance, it’s a near lock), AT&T Wireless will debut in April with an $8 billion-to-$10 billion IPO, the largest ever. Bell South may follow in its footsteps. Lucent (of which I own a few shares), itself a full-blown AT&T spin-off, is said to be considering trackers for its optical-networking or micro-electronics unit. “We’ll see them in drugs, finance, certain areas of tech, media, and communications,” predicts Barbara Byrne, a managing director at Lehman Brothers with expertise in restructuring.

Now that the AOL-Time Warner mating ritual has dispelled even the stodgiest money managers’ doubts about the Net, sectors like e-commerce and wireless communications are getting a disproportionately large share of the Street’s attention – and investment. “The way growth companies are priced has changed dramatically in just the last year to eighteen months,” says Byrne, “and when you’re making acquisitions, no one wants to take cash.” They want stock – the kind of stock that ratchets up gains dowdy blue chips can’t manage. And so even the most conservative companies are changing their capital structures to recast themselves as New Economy players with sexy stories to tell. None other than the New York Times recently indicated it would offer a tracking stock for its Times Digital group to try to raise up to $100 million – presumably to fund pricey acquisitions the Sulzbergers couldn’t otherwise stomach. Just as crucially, Times Digital stock options – unchained from the Gray Lady’s fusty print business and modest valuation – will help persuade top talent that has a twenty-first-century upside.

“We look at them as a bastardized spin-off. CEOs get access to cheap capital without having to give up any control, and bankers get a big fee. Investors – I don’t see what they get.”

In simple terms, a tracking stock is a separate class of common share that gives investors a way to link their returns directly to the performance of one or more business units within a large company. Its profits and losses are reported separately from the rest of the company’s, but it’s not a separate corporation – the same board of directors controls both the core company and its tracked offspring. So in some ways, a tracking stock is merely an exercise in Wall Street semantics: It doesn’t represent ownership of a separate company because there is no separate company to own.

The exact legal structure of tracking stocks can sound ambiguous – the practical differences between trackers and spin-offs show up only in extreme situations like bankruptcies and takeovers when tangible assets change hands and the IRS gets involved. But the reason for their current popularity is obvious: valuation, valuation, valuation. The gap between how the market values a technology start-up and how it treats a similar division in a large company has reached unprecedented magnitude, so in order to keep up, CEOs need to “unlock the value” within their empires. Issuing a tracking stock takes a successful division out of a big company’s shadow, giving conglomerates a way to mint pounds of shiny New Economy currency without giving up an ounce of control.

But like an employed adult child who still lives at home, a tracked business enjoys an independence that’s somewhat illusory. Sure, “he” may be in the early stage of a promising career, and he probably enjoys more lifestyle advantages (a better credit rating, shared costs) than if he were pushed out of the nest. But when it comes to the major decisions – allocating profits, accepting a merger offer – it’s still Dad’s house and Dad’s rules. Indeed, owning 51 percent of a business’s tracking stock gives you no more control than owning none.

For that reason, “we look at them as a bastardized spin-off,” says Joe Cornell, a principal of Spin-off Advisors, a Chicago research boutique that specializes in the area. “CEOs get access to cheap capital without having to give up any control, and bankers get a big fee. Investors – I don’t see what they get.” Except inferior shareholder rights: Tracked businesses often don’t get a meaningful vote in corporate issues that directly affect them, so they tend to lose out in the event of a conflict with their parent companies. “These are no different from conflicts in a conglomerate,” according to New York Law School securities-law professor Jeffrey Haas. “But here they play out in the realm of shareholders,” who can be hurt by a decision they can’t affect. (For her part, Byrne notes that some nontracked companies also issue nonvoting shares.)

One extreme example is Donaldson, Lufkin & Jenrette. When the company put out a tracking stock for its online DLJDirect, the prospectus reserved for DLJ the right to open a competing e-brokerage. That’s an important advantage for DLJ, but it would mean competition for DLJDirect – and bad news for its shareholders, who have little choice but to sell if the stock stumbles. “A tracking stock,” says the professor, “is the ultimate ‘trust us’ strategy.”

Even during the past year, trackers’ results have been mixed. PCS has tripled in value, but Disney’s is down more than 20 percent and Ziff-Davis’s ZDNet is off almost 10 percent. One reason is that corporate boards naturally tend to float tracking stocks for properties in high-flying, high-risk sectors – often late in the cycle of the trend.

The curious investor might also wonder how all this value got “locked up” in the first place. Are we really that sensitive to packaging? AT&T certainly thinks so: It’s betting that today’s growth-stock investors are less interested in good ol’ reliable Ma Bell than they are in start-up-style companies with little profit but big upsides. The multi-billion-dollar cash infusion generated by the IPO will jolt the wireless business into even faster growth. And the classic AT&T investors – you know, those oddballs who look for steady profits in a proven business – will be happy to see the wireless business stop bleeding red ink all over their blue-chip profit-and-loss statement. Think of it as financial gerrymandering that separates AT&T to each division’s advantage – only both sides of the city answer to the same mayor.

In point of fact, it may not matter to today’s average investor whether tracking shares represent anything other than the idea of a separate company, the actual ownership be damned. Once upon a time, people bought stocks because they paid dividends – cash on the barrel due to you because you owned part of a corporation’s assets and profits. But the tech sector’s ascendance has made dividends the exception instead of the rule. At most start-ups, it’s understood that profits are meant to be reinvested rather than paid out, so while you may legally be entitled to a piece of your stock’s earnings, you’ll never actually see it in your hand. The sole point of owning stock is that the share price will rise; the ownership of assets has effectively become a nonissue.

The rise of tracking stocks merely marks the latest step in the gradual uncoupling of assets from investment vehicles – and a sign of the times for a turn-of-the-millennium market obsessed with growth at all costs. (To get pomo, trackers represent the victory of the signifier, growth, over the signified – your ownership of the company that’s growing.)

In any case, few technology stocks trade according to a multiple of earnings anyway, for the simple reason that they don’t have any earnings to multiply. What does it mean to have a claim on profits that may never actually exist? In today’s market, it means not worrying about what you actually own a part of. The only thing that matters is that the next investor pays more for your shares than you paid the investor before you. And if you own a stock in a hot sector, like PCS or, come April, AT&T Wireless, you stand a decent chance that he will.

Track Record