Tyco International Ltd. (TYC:US) is continuing a tradition of favoring stockholders over bondholders by selling its flow-control unit to Pentair Inc. (PNR:US) without transferring a proportionate amount of debt to the new company.
The sale, a spinoff that gives Tyco shareholders a majority of Pentair, strips $435 million in earnings before interest, taxes, depreciation and amortization from the electronics firm while shifting only $275 million in net debt. Tyco shares gained the most in more than three months after the deal was announced March 28, while yields on its bonds are little changed.
The debt being transferred is a “puny” sum that fails to significantly trim Schaffhausen, Switzerland-based Tyco’s $4 billion of bonds (TYC:US), said Carol Levenson of bond researcher Gimme Credit LLC. Creditors sued in 2007 over Tyco’s previous breakup, claiming it should have repurchased their bonds at a premium because it was transferring “substantially all” of its assets. Bondholders at Tyco lost more than $1.2 billion 10 years ago, when a debt-fueled buying binge led to accounting errors.
“It’s a home run for shareholders; for bondholders, I think the overhang on the bonds, which has been there for several quarters, remains,” Joel Levington, managing director at Brookfield Investment Management Inc. in New York, which oversees about $25 billion, said in a telephone interview. “They haven’t been the most bondholder-friendly organization, and if you’re holding them, you’re holding them with that knowledge. This is just another step along that path.”
The company’s shares surged 4.3 percent the day of the announcement, the biggest gain since December, while investors demanded one extra basis point of relative interest on Tyco’s bonds as spreads narrowed one basis point on all capital goods and building materials firms, according to Bank of America Merrill Lynch index data.
The leverage, or ratio of net debt to Ebitda (TYC:US) that Tyco will shift to Pentair, at 0.6, is lower than the company’s current level of 0.9, according to data compiled by Bloomberg. Moody’s Investors Service, which rates Tyco’s finance unit A3, and Standard & Poor’s, which grades it A-, put the company on review for possible downgrade Sept. 19, after the initial spinoff plans were announced. When the Pentair transaction was revealed this week, they said they needed more information about the post- spinoff structure before they could act. Minneapolis-based Pentair, rated (PNR:US) Baa3 by Moody’s and BBB- at S&P, was put on review for upgrades.
“How the legacy bondholders are treated is not clear at this point,” Hitin Anand, a New York-based analyst at credit researcher CreditSights Inc., said in an e-mail. “Tyco bondholders certainly have a bad history.”
Tyco said in September it would spin off its flow-control unit, which makes valves and thermal controls, and its ADT division, a provider of home security and monitoring systems. The remaining company will comprise the Commercial Fire & Security unit, which sells building security systems and gear for firefighters.
Pentair struck a deal this week to merge with Tyco Flow immediately after it is spun off. The all-stock transaction values the unit at $4.9 billion including debt and gives Tyco shareholders a 52.5 percent stake in the combined company in a tax-free transaction.
Frank Sklarsky, chief financial officer at Tyco, said the $275 million net debt assigned to the flow-control unit is appropriate. The companies haven’t yet assigned the specific amounts of cash and debt to the deal, he said.
“We’re very confident that we’re going to have these three companies still at investment-grade rating,” Sklarsky said in a telephone interview. “We don’t see any cause for concern in terms of liquidity or credit risk for any of the bondholders.”
Credit-default swaps protecting Tyco’s debt have dropped to 79.72 basis points as of yesterday, down from 127.37 in September, according to data provider CMA. That means it costs about $80,000 a year to insure $10 million of Tyco bonds against default.
The new company will save about $140 million in management costs and taxes in 2013, partly by incorporating in Switzerland, where Tyco is based, according to a March 28 presentation.
Pentair, which saw its shares jump 15 percent on the announcement, “definitely got a sweeter end of the bargain,” Jody Lurie, a corporate credit analyst at Janney Montgomery Scott LLC in Philadelphia, said in a telephone interview. That leaves Tyco’s situation unclear, she said. “Creditors are kind of scratching their heads and wondering what this business is going to look like after the spinoff.”
Sara Zawoyski, Pentair vice president of investor relations, didn’t return telephone messages seeking comment.
Bondholders sued Tyco over a transfer of assets as part of its 2006 plan to split into three companies, including TE Connectivity Ltd., a communications equipment maker, and Covidien Plc, a producer of medical devices. In April 2008, Tyco agreed to pay $250 million to settle the lawsuit. Tyco’s biggest bondholders (TYC:US) include insurers Lincoln National Corp., Prudential Financial Inc. and Hartford Financial Services Group Inc., Bloomberg data show.
Bondholders lost money in 2002 after former Tyco Chief Executive OfficerL. Dennis Kozlowski spent $64 billion over eight years assembling businesses and swelling long-term debt to almost $20 billion. Moody’s eventually cut Tyco’s credit rating to high-yield, high-risk, or junk, status. The company became a symbol of corporate excess after a $2 million party that Kozlowski threw for his wife in Sardinia in June 2001, partially paid for by Tyco.
The Pentair deal wasted an opportunity to significantly trim Tyco’s obligations and now bondholders risk becoming lenders to a smaller and less profitable company after Tyco sells or splits off ADT, Gimme Credit’s Levenson wrote in an e- mail. Tyco could have spun off its flow business and used a dividend from the unit to pay down debt, she wrote in a March 28 research note.
“Clearly the Pentair deal eliminates one avenue for meaningful debt reduction,” said Levenson, who’s based in Chicago. “Tyco has gotten into trouble with its bondholders before with a spinoff.”
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