Tyco: Yes, It Could Get Worse


By Amy Tsao Not so long ago, highly acquisitive, diversified industrial conglomerate Tyco (TYC) was a popular investment for those who wanted a fast-growing company that represented lower risk than high-flying dot-com stocks. And even as it took them on a roller-coaster ride, many investors stuck by Tyco, which has measurable assets, several nuts-and-bolts businesses, and did $36 billion in sales last year.

The stock sold off early in 2002 as Tyco was eyed for possible accounting irregularities. Shares fell further when it said it would split itself up, and they took another hit when Tyco dropped the split-up plans.

Even through the tumult, plenty of investors pointed to Tyco's solid cash flow generated from understandable businesses, such as medical devices and fire-security equipment. And they believed the hard-charging chief executive at the helm could turn things around. But with the June 3 announcement of L. Dennis Kozlowski's resignation, many can't stomach the ride anymore.

BREAK-UP VALUE. Salomon Smith Barney downgraded Tyco to hold on June 4, and Merrill Lynch initiated coverage with a neutral rating. But the eight other Wall Street analysts who cover Tyco still have a buy rating or better on it, claiming that the break-up value of its businesses -- health care, electronics, telecom, fire-security systems, and financial services -- merits price targets substantially higher than its current $16.77 a share.

In such an uncertain situation, it might be worth recalling that many analysts remained bullish on Enron until the energy giant collapsed. And while no one is accusing Tyco of being another Enron, until the latest turmoil calms down, this stock probably isn't for the faint of heart.

Sure, it rallied on June 4 by 4% even as Kozlowski was indicted in Manhattan on charges of evading about $1 million in state and local sales taxes on art he had purchased (see BW Online, 6/5/02, "Kozlowski's Comedown"). The criminal charges came a day after his surprise resignation, which sent shares spiraling. On June 3 they ended down 25%, to $16, near the 52-week low of $15. And they've lost two-thirds of their value since Tyco announced a plan in late January to divide into four separate companies "to unlock value" -- and, analysts suspect, to assuage investor worry over its accounting.

LIQUIDITY CRUNCH? Tyco has said its accounting is clean and has promised to make its finances more transparent for investors and analysts. And the market's post-Enron skittishness may be having an undue impact on Tyco. But as the stock price continues to fall, the heavily leveraged company now confronts some serious balance-sheet problems.

Jeffrey Sprague of Salomon Smith Barney estimates that Tyco is facing about $6.2 billion in debt coming due over the next 18 months. As of the end of the most recent quarter, it had $4 billion in cash. And $2.3 billion of its outstanding debt could be paid in the form of Tyco stock. But even so, with $27 billion in total debt outstanding, this company will struggle to avoid a liquidity crunch.

The latest turn of events has many investors reasonably fearing that a lack of confidence in Tyco will make it even harder for it to sell financial-services division CIT to make the looming debt payments. Analysts say a successful deal is critical to CIT's survival. But being desperate to sell CIT in an already depressed environment for mergers and acquisition limits what Tyco can fetch for it. In May, Lehman Brothers backed away from an offer of around $5 billion, which is half of what Tyco paid for CIT just a few years earlier.

"A TOUGH BET." It looks like Tyco, which says it still plans to make a deal (possibly through a public offering) by June 30, will be lucky to sell CIT even at a steep discount. "It's doable by the end of this month, but at what price?" questions Rob Plaza, an analyst at fund-rating agency Morningstar. "It's a tough bet to make that Tyco is going to receive the cash it needs."

Though many professional money managers agree that Tyco's shares are undervalued, they can't justify buying at this time. "Is the stock depressed? Yes. But it's also extremely volatile, and you can easily get whiplashed," says Tim Ghriskey of Ghriskey Capital Partners in Greenwich, Conn. "All we're getting is bad news."

The latest was enough to convince Salomon's Sprague to downgrade the stock on June 4. "We have been a strong supporter of Tyco and believe there is significant value in its businesses," he wrote in his report. "However...we can no longer recommend the stock despite its low apparent valuation given the uncertainty caused by Kozlowski's departure."

EXIT JITTERS. Meantime, the health-care and fire-equipment businesses, which Tyco has been relying on to buffer it from the slowdown in more cyclical areas like telecom, will continue to be hurt by the ceaseless barrage of negativity. On June 3, Tyco reiterated that it expects to earn $2.60 to $2.70 a share this year, vs. $2.58 in 2001, when it earned $5.1 billion on sales of $36.3 billion. Yet margins in the second quarter were hurt by price cuts Tyco already had to make to appease clients nervous about the accounting rumors.

Kozlowski's sudden departure will likely cause even more jitters -- particularly among customers and workers. The situation could be made worse if any other high-level employees leave. "The loss of one or more [executives] would be detrimental to the company," Sprague wrote.

As a rule, sentiment -- no matter how negative it is to begin with -- takes a nosedive when the term "criminal investigation" comes up. One longtime investor saw the criminal probe into Kozlowski as the final straw, and he finally sold his remaining Tyco stock on June 3. He took a sharp loss after paying $40 a share in 2001. "We just felt, why ruin our year with this kind of situation when you can move on and do well with other investments?" he explains.

PLENTY TO PROVE. This portfolio manager fears that even though the charges against Kozlowski aren't directly related to Tyco, more bad news may be around the bend. "When you have a CEO that sets that tone, a lot of people want to go along on the get along," he worries. Tyco couldn't be reached for comment June 4.

If Tyco can hire a new CEO and sell CIT to pay down debt, that'll make its prospects more attractive, investors say. But Tyco still has to prove the wisdom of other acquisitions it made as part of its borrow-and-buy strategy of the past several years.

"It remains to be seen what these assets are worth. The company needs to be more transparent about its acquisitions," says Eric Jemetz, senior analyst at New Amsterdam Partners. "They need to focus on running the businesses, and they have to be more transparent." That's a tall order when the man who was CEO just a day ago is appearing in criminal court. Tsao covers financial markets for BusinessWeek Online in New York


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