By Lawrence A. Cunningham
Electronic-vehicle makers’ stocks (EVs) are among the hottest investments on the market today. For example, the market cap of Tesla /zigman2/quotes/203558040/composite TSLA +1.75% , still a start-up despite its celebrity status, exceeds $1 trillion and that of Rivian Automotive /zigman2/quotes/230726939/composite RIVN -0.45% , a start-up EV maker that just went public, exceeds $100 billion. Meanwhile, the market cap of automotive industry titans, while higher, remain relatively modest, with, for example, Ford Motor /zigman2/quotes/208911460/composite F +0.68% at $76 billion and General Motors /zigman2/quotes/205226835/composite GM -1.08% at $84 billion.
The vast difference in multiples probably reflect longstanding investor preference for pure-play businesses over more diversified ones. Pure-plays are easier to understand, offer greater visibility into the business, and can also entice higher growth and expectations-based investing. One thing we can surmise: those investors with an appetite for EVs are most likely different from those looking to invest in traditional car companies.
Ford and GM could simply spin off those businesses, but there are almost certainly valuable benefits for these automakers to continue incubating EVs alongside traditional vehicles. But that doesn’t mean these giants can’t create a little more visibility — and valuation — for their EV businesses. The answer: tracking stocks .
GM in fact was the pioneer in doing just that when it invented tracking stocks back in 1984 to solve a problem for H. Ross Perot, the colorful Texas billionaire. GM had acquired Perot’s company, Electronic Data Systems (EDS). He and his many employee-shareholders were concerned that EDS’s performance would be lost within the GM behemoth.
They wanted to ensure that superior performance of EDS would be rewarded regardless of how the rest of GM performed, including due to the relative time horizons of each company. The solution: the EDS group accepted shares in GM, but performance was tied to the economics and related time horizon of EDS, aptly dubbed “Class E” stock.
The invention was so effective that GM copied it the following year when acquiring Hughes Aircraft Company — using currency dubbed GM “Class H” stock. Both trackers remained in place for more than a decade until GM spun off the units, distributing all of GM’s stock in them to GM shareholders to form freestanding companies. GM’s tracking stock worked so well for all concerned that the model has been copied scores of times.
In 1991-92, for example, U.S. Steel Corporation enjoyed synergies through common control of such diverse subsidiaries as Delhi Group and Marathon Oil, which shared gas-processing plants and enjoyed lower borrowing costs together than if independent. But the businesses had distinct economics so that a tracking stock would both keep the advantages of common control while increasing visibility into the tracked business with gains for stockholders and managers alike. The solution worked for a decade until USX spun off Marathon Oil.
In 1995, after the government’s antitrust break-up of AT&T /zigman2/quotes/203165245/composite T +1.42% , US West was a regional telephone company that also owned cable and cellular assets. Long-term investors attracted to the stability of the telephone utility recoiled at the volatility of media assets; shorter-term investors seeking rapid growth had opposite tastes.
Trackers satisfied the demand of each while housing all operations under common control, harvesting related synergies. To further meet investor tastes, the utility side paid regular dividends as the media side reinvested earnings. The best part was that the arrangement could be unwound as circumstances changed. Indeed, in 1998, after synergies proved elusive, US West spun off the media business.
In the mid-1990s, the iconic investor and telecom mogul John Malone used trackers to segment the economics of the diverse media assets he had been acquiring for decades through TeleCommunications Inc. (TCI). In addition to other advantages ranging from antitrust to taxes, Malone realized that cable assets along with programming, for example, were better combined than separate from an operations perspective. Yet they featured different economic attributes. Using tracking stocks for such businesses could translate into higher price-earnings multiples, which can be valuable when using stock to acquire other companies.
As for downsides, as the distinguished investor Bill Ruane once lamented: on Wall Street, the process goes from innovation to imitation to irrationality. The same held for trackers, as they proliferated in the late 1990s technology sector. A common theme featured a traditional company offering trackers in an internet subsidiary — which critics complained helped stoke the irrational exuberance that fueled the bubble.
Debate over trackers ensued, some dismiss them as mere financial engineering which did nothing to increase fundamental value. Champions argue that they are a real financial achievement that increases value by deftly combining assets to cater to differing investor appetites while maintaining economic efficiency.
The truth is more mixed: some trackers are mere engineering and some are real achievements. The issue becomes whether there is a compelling rationale for a particular tracker. Ford and GM both seem to have compelling rationales to offer tracking stocks for their electronic-vehicle businesses. They’d certainly be easy to name: “Class EV” stock.
Lawrence A. Cunningham is a professor at George Washington University, founder of the Quality Shareholders Group, and publisher, since 1997, of “The Essays of Warren Buffett: Lessons for Corporate America.” For updates on Cunningham’s research about quality shareholders, sign up here.
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