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Tracking Stock

What is a tracking stock? This is a stock investment where a parent company is raising equity by selling a minority interest in one of its highly visible divisions to the public. The valuation ratio of a tracking stock is usually higher then that of the parent company, in effect advertising to the investment community that the parent has a prized asset. Additionally, because of the higher valuation of the tracking stock, it can be used as currency to make acquisitions, further enhancing the prospects of both companies. The tracking stock can also be offered to management as a form of sweat equity, as an incentive to conserve cash, while motivating their employees. The new investors only have an interest in the public tracking stock.

The board of directors of the parent company usually governs both companies. In many cases, the shareholders of the tracking stock have fewer rights than the parent company’s shares, as well as fewer votes per share. The parent will still control the subsidiary. Additionally, such administration functions as SEC reporting, taxes, etc. are usually handled by the parent company. The parent company may cross-collateralize the debt of the tracking stock, keeping interest expense low, as well as establish tax-sharing agreements to fully utilize tax benefits.

Tracking stocks normally have high growth potential and investor appeal, and are issued at high valuations. Parent companies can take advantage of this appeal, by pushing the negative aspects of growth to the tracking stock. Often, growth requires up-front cash outflows, initial losses, as well as higher debt levels and capital needs. These negative attributes can be transferred to the tracking stock, thereby improving the fundamentals of the core parent company, sometimes at the expense of the tracking stock, while also controlling the future profits of the tracking stock.

An innovative company that uses tracking stocks is Applera, which has two leading businesses with completely different business models. The businesses are kept separate and trade on the NYSE as separate tracking stocks. Applied Biosystems Group (ABI) is a leading medical and life science instrument manufacturer, while Celera Genomics (CRA), the second tracking stock, is a research and development drug company. Investors have the option to invest in the portion of the business that’s of interest to them.

A common investment strategy is to invest in the company that ultimately controls the profits of the tracking stock. Most business professionals tend to keep their most valuable assets, and sell their least attractive or most overvalued businesses first. This should translate into a “caution” sign. Since these types of securities are relatively new to the investment community, exercise prudence when purchasing them.


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