Bull's-eye market: will large companies in the UK soon embrace the American fashion of issuing targeted stock? Samuel Idowu, Anthony Brabazon and Kojo Menyah explain what targeted stock is--and what it can offer as a financial management tool.

AuthorIdowu, Samuel
PositionFinance Targeted Stock

Targeted stock is a relatively new class of equity that several large US companies have issued in recent years. Although no British group has yet followed suit, the London Stock Exchange has indicated that it would have no objection to this in principle.

Targeted stock (also known as tracking, letter or alphabet stock) is a special class of ordinary shares in a group designed to track the financial performance of a specific subsidiary or unit. It is an alternative to a spin-off or carve-out. Targeted stocks can be issued through an initial public offering, by way of scrip dividends, in a fights issue or by a combination of these methods.

Unlike typical ordinary shareholders, investors in tracking stock don't have a direct ownership stake in the assets of the specific business unit. The parent company keeps possession of the underlying assets. In essence, investors in the tracking stock are entitled to a dividend from the tracked unit, if one is declared, but they have no right to share the dividends of the parent company. The voting rights of targeted stockholders are normally restricted to the basic protection of their financial interests (see panel, right). They may have little, if any, say in determining the operational practices or long-term strategy of the unit.

When a company issues targeted stock, it generally produces detailed financial statements for the tracked unit as well as for the rest of the group. This transparency gives investors a clearer picture of the trading position and future prospects for the various parts of the business, in turn facilitating the valuation of each unit.

General Motors issued the first targeted stock in 1984 when it was bidding to acquire Electronic Data Services (EDS). Ross Perot, then the owner of EDS, was concerned that the efforts of his company's managers would have little impact on GM's overall performance on the stock market, so the use of GM stock options to reward them was unlikely to be effective. The proposal to introduce targeted stock for EDS's operations, which could then be used to motivate its managers, helped to convince Perot to approve the takeover.

More than 20 US companies--including AT&T, Sprint and Georgia Pacific--have since taken the plunge. One common feature of this trend is that the firms have generally used their targeted stock issues to raise the profile of a "star" subsidiary.

There are several arguments for the use of targeted stock, but it offers four main benefits at...

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