For an exercise in mind-numbing complexity, there's little to compare with a Tyco International Ltd. (TYC) financial filing. Take the quarterly press release the company issued from its official domicile in Pembroke, Bermuda, on Jan. 15. In addition to the usual operating earnings-per-share figures, Tyco highlighted two new accounting rules that had affected those numbers, detailed several hundred million in charges and credits, and a second set of pro-forma results. And that was just in the first paragraph.
With the conglomerate now planning to split into four separate units, is there any hope Tyco will become easier to understand? The company insists there will be more specific details available about each of the groups once they're split off. But that doesn't mean officials will be any more eager to explain the accounting behind the numbers. In responding to criticisms about Tyco's lack of detail in reporting new acquisitions, Chief Financial Officer Mark H. Swartz would only say his disclosure is already good enough. "We believe the disclosure we have is better than anyone's out there," he says.
There are plenty of reasons to watch closely as Tyco unwinds. Critics have long accused Chief Executive L. Dennis Kozlowski of using his confusing financials and an aggressive acquisition schedule to pump up earnings. One oft-repeated allegation is that the companies Tyco buys restate their results downward just prior to closing the deal. That way they immediately look better under Tyco's umbrella. Kozlowski has denied that he uses such tricks. Still, skeptical investors will want to scour Tyco's upcoming S-1 registrations. These will be filed with the Securities & Exchange Commission about a month before each of the three initial public offerings. The first deal, the spin-off of Tyco's financing business, is scheduled for March or April.
Count on Tyco to put its best foot forward, showing what are sure to be impressive pro-forma growth figures. But just as crucial will be examining each unit's debt level. Overall, Tyco's debt burden has been rising (chart). And in the past, some companies have used spin-offs to push a heavy debt load onto their departing divisions, notes Joe Cornell, principal of Spin-Off Advisors, a Chicago research firm. One incentive for Tyco not to do this is that it wishes to maintain its A credit rating for the new companies. Standard & Poor's has affirmed Tyco's rating for now, but says it's not clear if the security and electronics unit would get an A rating, given the cyclicality and higher risks of its businesses.
Tyco may also talk about each new company's interest expenses in the section, "Management's Discussion and Analysis." Comparing that number with operating cash flow should make clear how well the company can handle its debt.
Another big issue will be the goodwill Tyco built up through its acquisitions. Now, Tyco and its finance unit together carry $39 billion on their balance sheets to reflect premiums paid over the fair market value of the tangible assets bought. How that gets divvied up is key, says Lehman Brothers accounting expert Robert Willens. Those allocations should accurately reflect the acquisitions that created each unit. To track acquisition costs, you must check historical filings. Critics take Tyco to task for attributing too much of its purchases to goodwill, lowering its expenses. So any changes in these numbers will be closely watched.
Some of the best information will be buried far down in the offering documents. Investors will want to pay close attention to any mention of changes in the company's accounting procedures or legal policies. "A lot of the juicy stuff would be in the footnotes," says Spin-Off's Cornell. And if the numbers still aren't clear, follow the Enron rule: If you can't understand it, you shouldn't own it. By Nanette Byrnes, with Diane Brady, in New York