ISSUE NO. 2 2016
Highlighting Value Within: Tracking Stocks and Equity Carveouts
Over the last few years, companies have become more creative in issuing equity by unlocking the value of select business segments using tracking stocks and carveouts. For those looking to retain full control, these strategies can offer a path to expanding investor demand. They also help avoid the upheaval of complete separation, while providing a powerful currency for acquisition or as a means to de-lever.
1. WHAT IS A TRACKING STOCK?
It's a new class of parent company equity that tracks the economics of an underlying subsidiary or business. Tracking stocks don’t require the creation of a new legal entity or any significant reorganization of assets and liabilities, giving a parent company tremendous flexibility in structuring the new security. Importantly, tracking stocks typically have a built-in redemption feature so that the parent company can choose to collapse the structure at its discretion.
2. HOW IS A TRACKING STOCK ISSUED?
Tracking stocks can be issued in many ways, including:
- A sale to the public for primary proceeds
- A tax-free distribution to the parent company’s existing shareholders
- Through an exchange offer with existing shareholders
- As acquisition consideration
These methods can also be combined, making issuance extremely flexible. Prior to issuance, the parent company will generally need a shareholder vote to amend the charter to create a separate class of common shares.
A carveout is an IPO of a subsidiary by a company where a (generally minority) stake in the subsidiary is sold to investors, while the remaining stake is retained by the parent company. Typically, the parent company contributes the assets of a subsidiary to a newly formed entity in exchange for common stock, and the new entity subsequently sells common stock to the public in an equity offering. Carveouts are often viewed as the first step in a path to complete separation. Although the size of the carveout subsidiary relative to the parent company can vary, almost half of all carveouts are of subsidiaries representing 0% to 20% of the parent company, with a third involving a sale of less than a 20% stake.
Carveouts are different from tracking stocks since ownership in a legal entity is sold, as opposed to tracking economic rights. But like tracking stocks, they can help increase the aggregate demand for a firm’s equity by attracting new investors for the subsidiary.
Carveout size as a percentage of parent company value can vary significantly
3. BENEFITS AND CONSIDERATIONS OF TRACKING STOCKS
The issuance or distribution of a tracking stock to new or existing shareholders requires careful consideration.
- Tracking stocks and carveouts can be useful strategies for highlighting the value of certain business segments in a corporation
- Tracking stocks may attract new investors that otherwise would not have owned the parent company's equity
- Carveouts enable companies to raise equity capital by selling interest in a subsidiary while retaining a significant stake