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Pentair, Tyco’s Flow Unit Plan $4.53 Billion Combination

Tyco International Ltd. signage is displayed outside of the company's offices in Boca Raton, Florida. Photographer: Eliot J. Schechter/Bloomberg
Tyco International Ltd. signage is displayed outside of the company's offices in Boca Raton, Florida. Photographer: Eliot J. Schechter/Bloomberg

March 28 (Bloomberg) -- Pentair Inc. agreed to buy the flow-control unit created by Tyco International Ltd.’s breakup for $4.53 billion in stock, spurring speculation that Tyco’s remaining two pieces will also be sold.

Pentair management, which began talks on the deal in January after Tyco announced a three-way split in September, will take control of the flow unit immediately after the breakup’s completion. Under the deal’s “Reverse Morris Trust” structure, the buyer becomes part of a combined company in which Tyco Flow investors hold a majority stake.

The deal points to suitors snapping up the other two businesses created from Tyco, which analysts have said would be more attractive to bidders than the company as a whole. Those businesses are the ADT North American residential security unit, with yearly revenue of about $3 billion, and commercial fire and security with annual sales of $10 billion.

“Odds are very high that all Tyco pieces get sold,” said Jeff Sprague, co-founder of Vertical Research Partners Inc., who described all three businesses as possible takeover candidates last year. “What this shows is that Tyco management is being very creative and serious about maximizing shareholder value,” Sprague wrote in a note to clients today.

Credit Suisse Group AG reiterated its outperform rating on Tyco stock today, in part because of “further potential M&A catalysts,” Julian Mitchell, a New York-based analyst, said in a note to investors.

‘Growth Engines’

Pentair surged the most since 1984 as the company predicted earnings growth of 40 cents a share in 2013 and access to wider markets.

Pentair’s finances will improve with the transaction, and the markets Tyco contributes, especially in energy and infrastructure, will boost growth, said Joshua Pokrzywinski, an analyst with MKM Holdings LLC. The new company will probably find more cost savings than announced, he said.

“You’re gaining access to perhaps higher quality, secular growth engines with what Tyco is bringing on board,” Pokrzywinski said.

Pentair climbed 15 percent to $46.32 at the close in New York, while Tyco gained 4.3 percent to $55.81.

Manufacturing Facilities

The merger will create one of the few companies that offer valves, pumps and filtration to tap sales in developing nations where a middle class of 4 billion people are driving demand, Pentair Chief Executive Officer Randall J. Hogan, who will lead the combined company, said on a call with analysts and investors.

Pentair, with Tyco Flow, will have 100 manufacturing facilities and 90 service centers, he said.

“The combined company will have increased scale, broader geographic reach and greater access to high-growth attractive sectors,” Hogan said.

The transaction values the flow unit at about $4.9 billion, including debt and minority interest. That’s about 11 times the Tyco unit’s 2011 earnings before interest, taxes, depreciation and amortization, excluding non-recurring items, the companies said.

Combined Ebitda will be $1.3 billion in 2013 and is expected to rise to $1.7 billion by 2015, the companies said in presentations on their websites.

Tyco Flow Debt

As part of the transaction, the new Pentair will assume approximately $275 million of Tyco Flow debt, net of cash. The debt-to-Ebitda ratio will be about 1.6 times after the merger and will drop to 1 by 2015, giving the company a solid financial footing, executives said.

Tyco International CEO Ed Breen, who spent a decade transforming the scandal-plagued conglomerate into a Standard & Poor’s 500 Index outperformer, concurred.

“By putting these two companies together, you end up with a very strong balance sheet, which positions this new company for the future,” said Breen, 56.

The combined company is confident it will reach $250 million of annual cost savings by 2015, with $90 million coming on the first day. Executives expect an eventual $200 million from operational reductions and $50 million from tax savings.

Hogan said Pentair’s and Tyco Flow’s businesses are very complementary, especially Tyco’s valve business, and the cost savings won’t depend on shutting down facilities.

The new company will be the world’s largest flow, filtration and equipment-protection company, he said. It will retain Tyco’s incorporation in Switzerland to help with tax savings, and its main offices will be at Pentair’s headquarters in Minneapolis.

Tax Free

“Acquisitions will remain part of our strategy,” Hogan said. “We will be the biggest player in flow filtration and equipment protection and it’s still a fragmented industry.”

The board of the new company will include Pentair’s directors plus two members chosen by Tyco, which had said last year that Breen would be a director at the flow-control unit after the breakup. He was also to serve as a consultant to ADT and non-executive chairman at fire and security.

Breen succeeded Tyco CEO L. Dennis Kozlowski, who exited amid a criminal investigation for personal tax evasion. Kozlowski ran the company for a decade, boosting revenue with acquisitions. When Breen joined Tyco, revenue was about $35.6 billion. Last fiscal year’s sales were less than half that amount, after about 25 divestitures and splitting the company into three in 2007.

‘Tread Water’

Tyco’s ability to sell the flow unit lowers concern that the company would “tread water” until the breakup is concluded, said Scott Davis, an analyst with Barclays Capital Inc., who raised his recommendation on Tyco in a report today to overweight from equal weight.

The business was “the least attractive stand-alone asset,” Davis wrote. “The effective sale with attractive economics structurally improves the Tyco risk profile into the spin.”

The “Reverse Morris Trust” structure allows Tyco to preserve the tax-free nature of its planned spinoff while reaping the benefit of potential cost reductions from merging the business with that of Pentair.

In a Reverse Morris Trust, the buyer typically needs to be smaller than the division it’s acquiring. The special requirements of the structure, such as shareholders of the acquired company controlling more than 50 percent of the new business’s stock, make it “highly unlikely” that Tyco would be able to use a Reverse Morris Trust for its remaining two units, Breen said.

‘Stars Aligned’

“They don’t happen often,” he said. “This was just one of those unique times that the stars aligned to make it happen.”

Deutsche Bank AG provided financial advice to Pentair, and the firms of Cravath, Swaine & Moore and Foley & Lardner were legal counsel. Greenhill & Co. supplied an additional fairness opinion to Pentair’s board.

Tyco’s financial adviser was Goldman Sachs Group Inc., and the firms of Simpson Thacher & Bartlett and McDermott Will & Emery provided legal counsel. Lazard was financial adviser to Tyco’s board.

To contact the reporter on this story: Thomas Black in Dallas at Zachary R. Mider in New York at;

To contact the editor responsible for this story: Ed Dufner at;

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