Tracking stock

Tracking stocks are securities that are designed to have a value that reflects the value of a division of a company. Issuing a tracker is an alternative to a demerger or partial demerger.

A separate listing for a subsidiary should cause the market to separately value that subsidiary. This often increases the sum of parts valuations of the the parent company.

The problem with this is that the parent company loses some degree of control. The management of the subsidiary become accountable to the minority shareholders in the subsidiary as well as to the partent. If a large enough stake is sold (to raise more money) the parent could even lose outright control. It also scales down the size of the parent, which is not something that is likely to appeal to its management.

A tracking stock allows a company to both retain full control and have the benefits of the separate valuation of a division. A security is created that shares in the profits of a division, but that has reduced or no voting rights.

The end result of issuing a tracker is not dissimilar to selling non-voting shares in a subsidiary. It has the same drawbacks from the point of view of investors. Like a separately listed subsidiary, a division that has a tracking stock will report its financial results separately from the parent company and the tracking stock will trade separately from the parent company's ordinary shares.

While there are sometimes arguments in favour of tracking stocks, such as synergies between the division and the company as a whole, it is often difficult to understand the benefit to shareholders of issuing a tracking stock rather than selling ordinary shares in a subsidiary - or even demerging it completely.

One common justification is cheaper access to debt. The benefit of a parent company's good credit rating can be retained. This should adversely affect the parent company (by increasing its debt burden) so it is often difficult to be sure that there is a net benefit to shareholders.

Tracker stocks were very popular during the dot com boom, as companies used tracker stocks to exploit the high valuations that internet arms of large businesses could achieve. There is evidence that this partly represented a failure of market efficiency. They have since become less popular.

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