Finance executives inclined to jump on the tracking-stock bandwagon should first consider recent events at The Pittston Co. In December, Pittston announced plans to abandon three tracking stocks in favor of a conventional single issue. This retrenchment supplies a cautionary tale about what can go wrong when tracking stocks falter.
In the newest wave, companies issuing tracking stocks, or planning to, include AT&T, SBC Communications, Microsoft, Excite@home, Staples, J.C. Penney, Office Max, Pearson, Cendant, Aetna, and Countrywide Credit Industries, the biggest U.S. nonbank mortgage lender.
More than 40 tracking issues are now trading, and the enthusiasm might soon spread to other countries: Japan’s Keidanren, a federation of economic organizations at the heart of Japan Inc., began pressing the Tokyo government late in November to permit Japanese corporations to issue tracking stock.
At Pittston, however, enthusiasm has vanished. An old-line Appalachian coal company that diversified into services a generation ago, Pittston, based in Glen Allen, Virginia, set up tracking stocks in the mid-1990s to highlight its Brink’s and Burlington Air Express operations. Pittston Brink’s Group delivers money in armored vehicles and has a flourishing home-security business. Burlington, now called Pittston BAX Group, is a freight hauler and forwarder.
Pittston’s third tracking stock, Pittston Minerals, is its old mining side. Of Pittston’s $4 billion in revenues for the 12 months through last September, BAX accounted for 49.6 percent and Brink’s for about 40.1 percent. The coal business, once Pittston’s main operation, now barely exceeds 10 percent of revenues.
These tracking stocks added considerable market value until 1998. First BAX began to slide. Then Brink’s, the most profitable of the three, turned down early last year. By last fall, Pittston saw its market capitalization halved, to barely $1 billion.
In December, Pittston chairman and chief executive officer Michael T. Dan told securities analysts that the tracking-stock structure wasn’t working anymore. In conjunction with efforts to sell the coal mines, Dan decided to fold the tracking stocks back into a single corporate issue. Without the coal business, Dan reckons Pittston’s service arms would have generated $400 million of cash flow on $3.6 billion in revenues in 1999.
“Pittston’s tracking- stock structure was very successful in enhancing shareholder value when it was first introduced in 1993 and expanded in 1996,” Dan told shareholders last December. “However, given our substantial legacy costs, as coal-market conditions have continued to weaken and the profitability of our coal business has deteriorated, the tracking- stock structure has not resulted in appropriate valuations of our three stocks.”
Says Sandy Katzler, a Standard & Poor’s Corp. analyst: “The coal liabilities had begun to cast a shadow over the other two businesses.”
For issuers, a tracking stock provides a way to showcase an exciting, high-growth business unit that might otherwise go unnoticed amid the company’s other operations. What investors may not realize, however, is that they don’t own shares in the units directly (see “On The Right Track?”) Shareholders receive financial statements for the tracking-stock units, but they actually own shares in the parent.
Some tracking shares, in fact, have no voting rights at all. “It’s very hard to figure out exactly what your legal claims are,” says Wayne Mikkelson, a University of Oregon professor who follows tracking stocks. Says Paul R. Schlesinger, a securities analyst at Donaldson, Lufkin & Jenrette Inc.: “Tracking stock gives you no voting interest [in the unit it represents] and only a very limited economic interest. Mainly, it gives you a rooting interest.”
Unlike a spin-off, which turns a division or subsidiary into a stand-alone company with its own board of directors and management team, tracking-stock units remain entirely under the parent’s thumb. That gives managers great latitude in assigning assets. The first duty of the board and management, however, is to the parent–which sets up possible conflicts of interest over allocating costs or capital investment.
“As soon as companies run into a cash-flow bind, managers are going to look internally for sources of cash at other units,” says Mikkelson. “That’s when you’ll see shareholder lawsuits.” One suit has already been brought–by GM shareholders claiming they were duped by GM’s tracking stocks. A Delaware court ruled against them last summer on grounds that, as GM shareholders, they had voted for the tracking stocks in the first place.
Tracking-stock units share the same consolidated balance sheet with the parent’s other businesses–that is, all are liable if one unit can’t pay its debts. What doomed Pittston’s tracking-stock structure was shareholders’ realization that the company’s two favored tracking stocks, for Brink’s and BAX, shared in the huge liabilities of the coal business.
An absence of clear business strategies also worked against Pittston. “The tracking stock stopped working when the companies that backed the tracking stock stopped performing,” says Alex Brand, an analyst at Scott & Stringfellow Inc., in Richmond, Virginia, who follows BAX. Asked for their assessment, neither Dan nor Pittston CFO Robert T. Ritter would agree to be interviewed for this article.
Behind Pittston’s travails is the Coal Industry Retiree Health Benefit Act of 1992, which established a trust fund to provide pensions and medical benefits for laid-off coal workers. Coal producers were required to contribute to the trust fund, and the law specified that all of a company’s other subsidiaries were liable for the contributions. As some coal producers fell by the wayside, more of the liability accrued to the remaining companies. Pittston’s share of the liability is now $600 million.
Pittston turned to tracking stocks when Pittston’s former CEO, coal veteran Joseph C. Farrell, couldn’t bring himself to jettison the coal business and possibly sacrifice Pittston’s status as a Fortune 500 company. In 1993, Pittston divided its shares into two tracking stocks, one for coal and one for services. Pittston’s market cap promptly doubled. In 1996, it divided the services stock into two tracking stocks, for Brink’s and BAX. The company’s market value rose another 37 percent by year- end.
But not everybody was happy. “I dropped coverage of Pittston two-and-a-half years ago, partly because of the tracking stock,” says Merrill Lynch analyst Daniel Roling. “I felt I would have had to follow two other stocks in two different industries. You really have to follow all three pieces in order to understand the financial risks.”
Also, with coal prices in a downward trend since the early 1980s, Pittston decided to cut production and put its resources into its service arms. According to Jonathan Leon, a Pittston investor-relations spokesman, the company figured that making its coal operation competitive would require $300 million in investment over the next few years, and it decided to direct that capital to the service businesses instead.
In 1998, for instance, Pittston increased its borrowings by $218.4 million. It then hiked capital expenditures at Brink’s by 34.7 percent, to $156.6 million, and nearly doubled the sum for BAX, to $116.3 million. The coal side went begging: its capital spending, already skimpy, fell 8.3 percent, to $24.2 million.
Roling, however, foresaw that shrinking coal production would only worsen the impact of the retirement liabilities. Other major coal producers, such as Peabody Coal, expanded production to spread the liability over a broad base.
Meantime, another leg of Pittston’s three-legged stool began to wobble. Although its freight-forwarding business was flourishing in Asia, BAX seemed to have no clear focus in the U.S. market. Because it owned airplanes, for example, it was flying largely empty planes, with cargo that would more profitably have gone by truck. Earnings turned to deep losses in 1998.
Soon after, the board eased Farrell into early retirement and installed Brink’s boss Mike Dan in the CEO post. Dan became chairman at the beginning of last year, and soon brought in new managers to run BAX and the coal business. BAX is now turning up smartly, but the coal side remains crippled.
Dan now wants to sell the coal assets. No one, of course, will buy the liabilities. Pittston is setting up a Voluntary Employees’ Beneficiary Association (VEBA), which it hopes will be funded mainly by proceeds from selling the coal mines. The rest will have to be made up with annual contributions from Pittston’s remaining businesses. An advantage of the VEBA structure is that those contributions, and any portfolio gains, are untaxed.
Pittston’s gargantuan coal liabilities make its problems unique to some extent. But the basic problem of the tracking stocks sharing a single balance sheet is a common one that may create big headaches for other corporate managers in the future. In a sense, too, Pittston is a victim of old- fashioned conglomerate thinking. “There’s no logic to having these things together, so I don’t know what they were thinking,” says Alex Brand. “The current management team came to the same conclusion: They ought to have separate management teams.”
Brand is one analyst who believes that had BAX not borne the liabilities for the coal side, it would have been sold long ago. “I think the impetus is to actually separate [BAX and Brink's] at some point,” he says. There are likely buyers, too, for the Brink’s home-security business, which boasts 20 percent profit margins. Getting back to a single stock should open up all sorts of options for Pittston.