LAGUNA NIGUEL, Calif. -- The old saw had short skirts in the 1920s and 1960s as bullish signs for the market, and that makes you wonder if platform shoes might have been the precursor to the performance of Net stocks. But the hottest fashion in finance goes beyond hemlines and footwear. Now the latest thing for Wall Street is the tracking stock, or "designer stock," as it's known.
But defining the thing is like defining good taste. Try asking Wall Streeters what a tracking stock is. "That's a better question than most people realize," says Nick Moore, an analyst with
Jurika & Voyles
. "And the deeper you dig, the harder that question is to answer." But it's one that investors are about to face head on and that challenges the value of almost every Net stock out there.
Titanic companies like
are all reportedly considering spinning off their Internet properties with Internet tracking stocks, and that means investors in the Net will have to figure out just what they might be buying.
The simple answer is, well, simple. A tracking stock is a category of common stock that pays a dividend based on the operating performance of a part of a corporation. So if
Ben and Jerry's
wanted to let people invest in Cherry Garcia, the company might issue shares in
Cherry Garcia Co.
All future results of Ben and Jerry's would not include earnings from the sales of Cherry Garcia -- even though Ben and Jerry's technically still owns Cherry Garcia. On the Street, these shares are known as "designer" stocks, or "letter," stocks since the new issues often have another letter on the end of its stock symbol.
"If indeed a company has an asset that is not fully valued," says
, "a tracking stock is something they should consider."
The mother-of-all-tracking stocks was that of onetime
. General Motors bought EDS from
but very quickly found that there were problems.
"Software guys didn't want their fortunes tied to the sales of Chevys," says David Readerman, Internet analyst with the San Francisco investment bank
Thomas Weisel Partners
. In the pre-Internet days, Readerman covered EDS. "EDS people said, 'Hey we're in the software business and we should get paid in stock options.'" So in October 1984, the company issued shares of GME to track EDS performance. EDS would still get the cheap credit and financial benefits that accompany a global powerhouse like GM, but EDS would get a separate stock for acquisitions and employee options.
So why don't all these corporations drink the tracking-stock Kool-Aid? "It can create all kinds of pain and angst," says Ruth Porat, Morgan Stanley's co-head of global technology banking. "These can be serious moral problems."
Imagine the internal strife that would occur at Time Warner if, say, the skilled editors at
, with decades of service, saw pimply editors at
suddenly enriched with newly minted shares of Internet stock.
Another problem: Shares of the corporate stock generally fall when the fast-growing assets are removed from the corporate balance sheet. Shares of brokerage
Donaldson Lufkin & Jenrette
have fallen 21% since it announced plans in mid-March for a tracking stock of online brokerage
-- while the
S&P Banking Index
has fallen just 0.2 %. The tracking stock debuted May 26. Says Meeker: "A tracking stock can expose a weakness that a company might not want exposed."
S&P Banking Index Outpaces a Net-less DLJ
No two tracking stocks are alike, and therein lies another problem. One manager of a $3 billion mutual fund says that there are some corporate boards he wouldn't trust with a tracking stock. "You get these dividends at the grace of the corporate board," he says. "So you have to have a lot of faith in the kind of company doing this kind of deal."
So why not do a simple spinoff? To large corporations, there are big tax advantages to tracking stocks. Generally speaking, shareholders aren't taxed when a tracking stock is created, not so for a spinoff. And some federal regulations prevent spinning off an asset that's fewer than five years old.
But for old-economy companies, there are no easy solutions. When they refuse to maximize their share value, employees might leave for Internet companies that will. And if they do spin off their Net assets and try to join the Internet economy, the old economy gets that much older in a hurry.