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T H E VOLUME 8, NUMBER 3 OCTOBER 1999 THE MONTHLY REVIEW OF TAXES, TRENDS & TECHNIQUES TRACI~ING STOCI~ MAI{ES PANEL PUBLISHERS NEWS (AGAIN) by Robert W. Wood • San Francisco EDITOR-IN-CHIEF Robert W. Wood Much has been said over the past few years about tracking stock. Shorn of its Robert W. Wood, P.e. details, tracking stock is merely equity issued by companies that want to San Francisco separate their typically higher growth or sexier divisions from their stodgier components. It is, in a way, a spinoff without a spinoff. If the tracking stock ASSOCIATE EDITOR and the parent company's stock are traded separately, they should arguably Vaughne Sprowls be worth more than the stock of a single company. Tax Institute Sounds an awful lot like spinoff analysis, doesn't it? And that's part of the San Francisco Service's problem. Although tracking stock has been kicking around in the tax and financial literature for quite some time, America's love affair with ADVISORY BOARD tracking stock is now branching out into the general press. The use of tracking Gilbert D. Bloom stock over the past few years has been monumental. A recent article counted KPMG Peat Marwick roughly 36 tracking stocks on the market. Washington Four of them have been issued just this year, including giants like AT&T and Lawrence B. Gibbs Donaldson Lufkin & Jenrette. Other tracking stock issues expected shortly Miller & Chevalier include J.C. Penney, DuPont, and Quantum. Even Walt Disney Co. and Washington Microsoft are both said to be looking at tracking stocks, primarily to track (and Richard M. Lipton enhance the value of) their internet subsidiaries. Plus, so-called brick-and- Sonnenschein, Nath & Rosenthal (continued on page 2) Chicago Steven K. Matthias Deloilte & Touche San Francisco Mark A. Muntean Bechtel Group, Inc. San Francisco Matthew A. Rosen Skadden, Arps, Slate, Meagher & Flom New York Joseph L. Schiffhouer Federal Express Corp. Memphis Mark J. Silverman ALSO IN THIS ISSUE: Steptoe & Johnson Washington Devices Under Section 355: Who, Me? ............................... 6 Robert Willens Morris Trust Regulations At Last (First of Two PaIts) ....................... 7 Lehman Brothers New York THE M&A TAX REPORT TRACKING STOCK MAKES without the risks. Plus, there are well-publicized NEWS (AGAIN) difficulties getting an IRS spinoff ruling. Id. Even from a financial viewpoint (aside from tax (continued from page 1) implications), tracking stock may not be a panacea. mortar retailers have launched online divisions. To There have been a few notable cases where tracking try to keep up with some of the hype of the internet, stock has been issued and the parent company has some relatively staid companies (like Federated suffered a blow in its stock price. Donaldson Lufldn Department Stores, Inc. and Wal-Mart Stores, Inc.) & Jenrette, for example, took quite a hit earlier this are thought to be looking at tracking stocks as well. year after the debut of its DLJDirect tracking stock in (For discussion, see Vickers, "Are Two Stocks Better May of 1999. Perhaps because its tracking stock Than One?" Business Week, June 28, 1999, p. 98. ) attracted all the attention, the "mother ship" looked more like an abandoned hulk. (For further details see Tracking Value Vickers, "Are Two Stocks Better Than One?" Business From a financial point of view, a recent analysis of Week, June 28, 1999, p. 98.) tracking stocks suggests they are doing exactly what they are designed to do: increasing value. However, Taxing Tracking the Internal Revenue Service and its authority over The taxation of tracking stock has lately come into the corporate reorganization domain have been the limelight. The fiscal 2000 budget included many undercut if one views tracking stocks as a real controversial revenue raisers, not the least of which alternative to spinoffs which must meet rather was the proposal dealing with tracking stock. The rigorous requirements. budget proposal called for the issuance of tracking Some argue that tracking stocks have nothing to stock to be treated as a taxable event. The issuer of do with alternatives to Section 355 while some argue the tracking stock would be viewed as constructively the opposite. In any event, the standalone Section selling the tracked assets for cash equal to the fair 355-spawned company can suffer from problems. market value of the tracked assets. Indeed, standalone internet companies (particularly The gain would be based on the excess of this of late) may have a hard time financing negative value over the tax basis of the assets. Presumably the cash flow. Having a clear connection to a "mother term "issuance" would encompass stock dividends ship" can have advantages. Tracking stock is and secondary offerings, as well as the use of tracking therefore thought to offer the benefits of a spinoff stock as acquisition currency. So the reach of this kind of change would be broad. Thc M&A Tax Report ISSN 1085-3693 is published monthly If this proposal were enacted, it would likely sound by Panel Publishers, a division of Aspen publishers, Inc., A Wolters KlulVer Company, 1185 Avenue of the Americas, New York, NY the death knell for tracking stock. It would be 10036. Subscription price, $375 per year, single issue price, $32. particularly onerous in cases where the issuance was Multiple subscription rates are available upon request. Copyright ©1999 by Panel Publishers, Inc. All rights reserved. First-class not accompanied by the receipt of cash with which postage paid at New York, NY, and additional mailing offices, to pay the tax. A no-cash issuance is common, as POSTMASTER: Send address changcs to: where the stock is paid out in a stock dividend or in The M&A Tax Report, Dept. ADV, connection with an acquisition. PO Box 3000, Denville, NJ 07834 Due to the absence of grandfather protection in the Customer services: (800) 562-1973 Editorial queries: budget proposal as it was written, it would severely Robert W. Wood penalize corporations that had already incurred the Robert W. Wood, PC. costs associated with adding tracking stock to their 477 Pacific Avenue, Suite 300 San Francisco, CA 94133 capital structures. The long effort that is often (415) 834-1800 expended in setting up a tracking stock program Fax: (415) 834-1888 would be wasted if the ability to utilize tracking stock Editor: Robert W. Wood Publisher: Dean Vogel was taken away by virtue of this proposal. It is Director of Circulation: Gerry Centrowitz possible a transitional window could be developed Product Development: Carol Lillienstein Managing Editor: Richard Niles (much like the window is closing on pooling). Production: Michele Jankowski This publication is designed to provide accurate and How Do You Spell Relief? authoritative information in regard to the subject matter covered. Fortunately, it may not matter that there is no It is sold with the understanding that neither the authors, the editor nor the publisher is engaged in rendering legal, grandfather relief. Many find tracking stock to be a accounting or other professional services. Illegal advice or perfectly legitimate corporate finance tool, and are other professional assistance is req uired, the services of a competent professional should be sought. (continued on page 3) 2 THE M&A TAX REPORT TRACKING STOCK MAKES Liberty Media NEWS (AGAIN) Recently, Liberty Media, a subsidiary of AT&T whose (continued from page 2) performance is represented by a class of AT&T tracking stock, announced the acquisition (using convinced that tracking stock is not utilized for tax tracking stock), of Todd-AO. Tracking stock as avoidance purposes. One Congressional and/or IRS acquisition currency is one of its most valuable concern is that tracking stock can be used in lieu of attributes. This is particularly true in cases where, as a spinoff that could not qualify under Section 355. in the Liberty situation, the tracked subsidiary is part Yet, the anti-tracking stock proposal has been of a much larger entity. The shareholders of a roundly criticized by professional organizations, like prospective target may not be willing to accept stock the AICPA and the New York State Bar Association. of the larger entity because that stock will reflect the Perhaps in part due to such adverse reactions, the performance of all of its business endeavors rather original budget's anti-tracking proposal does not than the performance of only the target. appear in either the House or Senate budget The ability to offer a more focused variety of equity submissions passed by each body. Accordingly, the security can help to preserve the target's use of tracking stock to achieve a myriad of entrepreneurial spirit and ensure that the target's corporate purposes (without tax!) seems likely to business is still a relevant factor in the performance still flourish. Ironically, perhaps the President's of the security the target shareholders obtain. In this proposal only underscored the uses (and perhaps case, the acquisition will probably be effected by even abuses) of tracking stock. Liberty Media (it will function as the acquiring corporation), which will issue stock of its parent Tracking Rulings (AT&T's Liberty Media tracking stock) to the Todd­ Although the IRS has historically declined to rule on AO shareholders in exchange for their stock in the the tax consequences of transactions that feature latter. tracking stock, a recent IRS pronouncement touches For tax purposes, this transaction constitutes a on one aspect. A spinoff will not qualify for tax-free triangular B reorganization. It is an acquisition of the treatment (at the distributing corporation level), if stock of a corporation (Todd), in exchange solely for the spinoff constitutes a disqualified distribution voting stock of the acquiring corporation's parent.

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