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Too Late To Jump Back Into Tyco?


Numbers course through stock markets like blood through the living. Common as numbers are, we can thank Tyco International's ex-execs, the most exalted of whom now stand trial a brisk walk north of Wall Street, for two fresh sets sure to get investors' pulses racing: "lawyer hours" and "accountant hours."

In Tyco's case, these would be 15,000 of the lawyer variety and 50,000 of the accountant's. Tyco consumed them after its former CEO, Dennis Kozlowski, and CFO, Mark Swartz, left last year amid charges they had looted the company, allegations to which they have pleaded innocent. Tyco's new CEO, Motorola veteran Edward Breen, had to end his first year in July by restating Tyco's financials back to 1998. And, as the Kozlowski-Swartz trial began in September, Tyco took out big advertisements reminding us of its new order. "Despite the distractions of the recent past, Tyco is a $37 billion company that sells real products to real customers," they say. "The present is great. But our potential for growth in the future is even greater."

Is it? At $22 a share, Tyco has nearly doubled from its low in March. While Breen is keeping quiet until Nov. 4, when Tyco reports its results for fiscal 2003, ended Sept. 30, he already has signaled 2003's likely outcome and raised expectations for improvement in the years ahead. Given Tyco's new financial basis and outlook, the question for investors is whether the stock remains a growth opportunity.

TYCO'S $37 BILLION in fiscal 2003 sales came from dozens of units grouped into five segments: Fire & Security, with its ADT Security Services; Electronics, which makes connectors, cables, and many other components, high-tech and low; Healthcare, where it notably competes with Johnson & Johnson in surgical supplies; Engineered Products & Services, a maker of such heavy-duty stuff as valves; and Plastics & Adhesives, a seller of duct tape, clothes hangers, and trash bags.

If many of these businesses lack glamour, the good news is that Tyco expects they yielded $2.2 billion to $2.5 billion in free cash flow during the fiscal year just ended. The bad news is that most or all of the company's 4% gain in revenue in its first nine months owed to changes in foreign currencies. And from the standpoint of a prospective investor, the worse news is that despite shadows cast by the trial, the stock market already fully expects Tyco to make good on its potential.

Tyco's market value comes to $48.5 billion. Tyco also owes $17.8 billion. Add the two to find how much capital a theoretical buyer of the whole company would need to use and Tyco now has a total enterprise value of $66.3 billion. Breen has told the Street he sees revenue growing 5% or so over the next few years, but that cash flow can expand much more rapidly. Suppose it surges by 25% or so to, say, $3 billion in the current year. On its present enterprise value, that would be a 4.5% cash return. How does this compare with solid citizens among Tyco's peers? Not well. J&J's free cash flow could run flat and still return nearly that much, 4.3%. Ditto 3M's. What about a hike in Tyco's 5 cents annual dividend, a yield of just 0.2%? For now, Tyco plans to divert spare cash to cutting debt and bolstering its pension plans. Stock in J&J and 3M comes with dividend yields of 1.9% and 1.8%, respectively.

With the stock reflecting a full valuation, Tyco's new leaders can be proud of stabilizing the company and starting to work off its financial debts. As for the moral obligations racked up by their predecessors, we will have to keep an eye on Manhattan's criminal court. If Kozlowski and Swartz are convicted, they could face prison terms of up to 30 years. For each, that would work out to 262,980 "convict hours," a memorable contribution to Wall Street numerology.

Corrections and Clarifications

"Too late to jump back into Tyco" (The Barker Portfolio, Oct. 27) incorrectly presented the cash returns to a theoretical buyer of all of Tyco International Ltd (TYC). The free-cash-flow figure that was cited for Tyco's 2004 fiscal year should have excluded the interest expenses that a buyer of the entire company would not have to pay. In the correct analysis, Tyco might yield a cash return of 6.2%, not the 4.5% reported. Contrary to the conclusion drawn in the story, this compares favorably with the cash returns of two Tyco peers, Johnson & Johnson (JNJ) (4.3%) and 3M (MMM) (4.4%).

By Robert Barker


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