The Long, Hard Road Ahead for Tyco


When a relieved CIT Group CEO Albert R. Gamper Jr. rang the opening bell at the New York Stock Exchange on July 2, he did more than mark the return of his commercial-finance giant to the Big Board after 13 months as part of Tyco International (TYC). He also signaled that at least one dark cloud hovering over Tyco -- the fear of an imminent liquidity squeeze -- had lifted. Tyco still faces some potentially enormous gales ahead, however.

Even though the July 1 CIT (CIT) IPO had to be priced well below the $5 billion to $5.8 billion Tyco was hoping to raise, it was the best news to come out of Tyco in months. The $4.6 billion that Tyco earned from the offering, combined with at least $2.5 billion of cash on hand as of June 30, means "we can meet all our obligations without refinancing any debt or selling any assets from now until November, 2003," said interim CEO John F.Fort III in a July 2 conference call.

NEW SKELETONS? Tyco's challenges are plentiful. Most ominous are investigations that have recently been launched by the Securities & Exchange Commission, the Manhattan District Attorney, and Tyco's own outside counsel. In the wake of last week's huge WorldCom and Xerox restatements, "investors are tremendously worried" that these probes "may find new skeletons in Tyco's closet," says Michael Jaffe, an analyst at Standard & Poor's.

Amid all this, Tyco's badly discredited board -- led by Fort, who headed Tyco for a decade before turning over the reigns to the now-disgraced Dennis Kozlowski -- faces the Herculean task of finding a strong new CEO who can rebuild both the board and management team. "For this company to regain credibility, you need a clean brush," says David Dreman, chairman of Tyco investor Dreman Value Management.

Ultimately, the new CEO will have to determine whether it even makes sense to hold this $36 billion empire together, absent the frenetic dealmaking that fueled most of its growth over the past decade. The upshot, concludes Merrill Lynch analyst John Inch: "This company is hardly out of the woods."

RISING HEAT. Even so, the offering's completion was anything but a ringing endorsement of Tyco's business acumen. It raised just 40% of the $11.3 billion Tyco had squandered on this ill-advised foray into financial services since May, 2001.

Moreover, even as the CIT road show was under way in late June, investigators were turning up the heat on Tyco. Sources close to the Manhattan District Attorney's office -- which has already criminally indicted former Tyco CEO Kozlowski for sales-tax evasion -- say the probe is now expanding to look into possible misappropriation of corporate funds.

Meanwhile, the SEC, which appeared to clear the group's accounting in mid-2000, is taking a fresh look at its acquisition-related math. It's also checking out allegations that Tyco may have violated the Foreign Corrupt Practices Act by paying bribes to win a contract in Venezuela.

NOT WORLDCOM? Concerns linger among some Tyco watchers that the IRS will come down hard on the outfit's strategy of avoiding U.S. taxes -- to the tune of over $600 million last year alone -- by moving income offshore. "If the IRS were prepared to commit sufficient resources to this problem, they could come up with some very, very substantial additional revenues," predicts Abraham J. Briloff, a retired accounting professor at Baruch College who has studied Tyco's finances.

In the July 2 conference call, Fort argued that investors have nothing to fear. "Something like WorldCom couldn't happen here," he argued, saying Tyco's books have been repeatedly and thoroughly combed. But Fort's reassurance wasn't enough to quell fears in a market badly spooked by repeated accounting scandals. As a result, Tyco's shares fell 8%, to $12.65, by the end of trading on July 2. They have now lost 78% this year, wiping out over $90 billion in market value.

Even if Tyco can avoid a big restatement, it must also stem the slide in its earnings. Just last December, Kozlowski said he was "comfortable" with estimates that Tyco could earn $3.70 per share -- or over $7 billion -- from operations in its current fiscal year, which ends Sept. 30. By late June, the Street had slashed that estimate to just $2.55, because of the weak economy and the disruptions Tyco has suffered amid all the bad publicity.

WANTED: A CEO. Subract CIT, and Tyco now concedes it will earn no more than some $2 per share this year, or about $4 billion. And that's not counting the massive write-offs it has been forced to take for both CIT and its troubled telecom unit. Counting those, Tyco lost nearly $5 billion in the first half of this fiscal year.

To stabilize itself, Tyco needs strong new leadership. But the ongoing crisis only compounds the challenge of finding a topflight CEO. "We're in a very risk-averse environment," cautions Peter Crist, vice-chairman at executive recruiters Korn, Ferry International. "If you're an A-level player, you have no reason to risk your career on a really, really tough situation like Tyco," he says. It could take six months to complete the CEO search, Crist predicts.

That's a seeming eternity in an environment in which many investors are also clamoring for new outside directors and a CFO to replace Mark H. Swartz, Kozlowski's long-time sidekick. "He's part of the old regime," says Dreman. "And as long as the old regime is there, it raises doubt."

JUICY BREAKUP VALUE. Believers like Dreman contend that, unlike Enron, Tyco retains a core of solid industrial operations and companies. On July 2, Swartz insisted that these businesses have now bottomed and that Tyco will earn at least $4.2 billion, or $2.10 per share, in fiscal 2003. Even if a new CEO decides to liquidate this disparate collection of businesses, earnings at this level should justify a breakup value of at least $40 billion, or $20 a share, argues Merrill analyst Inch.

Maybe so. But given all the challenges that lie ahead, it will likely be months -- at best -- before Tyco's true value becomes apparent. By Bill Symonds in Boston


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