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In the confusion, some are apparently blaming the recent AT&T Wireless Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AWE)") else Response.Write("(NYSE: AWE)") end if %> IPO -- America's largest initial public offering (IPO) by a wide margin. But the culprit is just plain old earnings, or lack of anticipated earnings to be specific. AT&T made its first quarter estimates but issued guidance that painted a picture of slowing growth for the rest of the year. As usual, any sign of weakness brought out the sharks.
Far from being the cause of the decline, I expect that the AWE IPO will be very good for AT&T. Tracking stocks are all the rage and for good reason. They are an odd breed, but I like the basic idea. It evens the playing field.
The first investing book I ever read was One Up on Wall Street, Peter Lynch's first book and still one of my favorites. He tells the tale of L'Eggs, a hugely innovated product (with a sense of humor!) that put panty hose in the grocery story and did nice things for Lynch's early reputation as a stockpicker. He mentioned that the stock went up 600% before being bought out by Sara Lee <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLE)") else Response.Write("(NYSE: SLE)") end if %>.
Once Hanes became part of Sara Lee, an investor lost the ability to profit from what Lynch called the Power of Common Knowledge. Even though L'Eggs probably still generated a ton of money for Sara Lee, the corporation was so huge that no one product line could contribute significantly to its earnings. It would make no sense to buy Sara Lee just because you thought L'Eggs were going to be big.
When I worked for Foolish Customer Service, we frequently got notes from readers asking how to find out who made a certain product. They were trying to get in on a consumer product that they had tried and liked. (The answer was that it isn't easy. There is a brand directory that lists the corporate owners of many brand names in the reference section of many public libraries, but I usually advised just calling the company and asking who owns it and if the parent company is publicly traded.)
Tracking stocks give the public the chance to profit from the Power of Common Knowledge. Owners of the tracking stock can buy an economic interest in the future earnings of just one small part of a large corporation. It makes sense to do that if you think that the profit-making potential of that division is likely to be greater than the profit-making potential of the corporation as a whole. The interesting thing is that the parent corporation probably agrees with you. Otherwise, why create the tracking stock to begin with? You don't single out your worst division and sell the rights to its profits to the public. That would be embarrassing.
Not that every tracking stock is an automatic winner. But it wouldn't be wrong to assume that every tracking stock is expected to be a winner by the parent corporation -- and who's in the best position to judge?
So about now, you may be wondering why a corporation would create a tracking stock? I mean, why sell off the rights to the future earnings of your company's potentially best performing division?
AT&T's sale of tracking shares in AWE illustrates the reasons nicely. We can see the advantage for the general public, but what were the advantages to AT&T shareholders?
AWE is still a baby with growing pains. It represents potential, but not current earnings. It faces huge capital demands while it builds its infrastructure. Separating, at least on paper, its near-term performance will improve the bottom line for the rest of AT&T.
AT&T's net from the offering, just over $10 billion, will buy a lot of infrastructure. Seven of the $10 billion has been allocated to AWE to fund its growth, freeing AT&T Corporate from that obligation. The remaining $3.3 billion goes into AT&T general corporate account where it may help fund further acquisitions.
But the real value lies in having established a market value for this one division of AT&T. One of these days, people are going to notice something interesting. AWE now has a market cap of around $70 billion. AT&T has a market cap of $118 billion. If you subtract 70 from 118 you have all of AT&T that isn't the AT&T Wireless Group being valued at $48 billion... all the cable companies, the ISPs, all the long distance facilities, the business services, the datanets, the laboratories.... You get the picture. When will Wall Street?
Of course, it's not that simple. Only 16% of AWE is publicly traded right now. The $70 billion market cap assumes all shares are valued at the same price as the publicly traded shares. The law of supply and demand could conceivably reduce the price per share if all shares were publicly traded. And, of course, all those other AT&T divisions have to make money. But the recent slaughter of AT&T's price over short-term projections of slow growth seems like a major overreaction in this light. (And those overreactions are just what Foolish Four investors wait for.)
Right now, AT&T shareholders have also benefited from cold, hard cash -- cash that is needed to build out a promising, but currently money-losing, division that they still have an 84% economic stake in. In the future, AT&T has said that it expects to eventually dispose of the remaining 84% by distributing some shares of AWE to existing shareholders. They may also offer to exchange shares of AWE for shares of AT&T (like the recent General Motors / Hughes deal) or by selling additional shares in another public offering. Exchanging shares of AWE for AT&T will reduce the number of AT&T shares outstanding, driving up future earnings per share, always a nice prospect for shareholders
So, welcome back, Ma. I hope you stick around for a while so lots of Foolish Four investors can grab onto your apron strings.
Fool on and prosper!
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