Commentary: Why Tyco Quit Dealmaking

The sudden about-face of L. Dennis Kozlowski, chief executive of Tyco International Ltd. (TYC ), is striking evidence of how radically the business landscape has shifted since Enron Corp.'s (ENE ) collapse. Only last May, as he was putting the finishing touches on his $10 billion takeover of CIT Group, Kozlowski said that he was just getting started. He figured he would easily do another $50 billion worth of deals in the coming five years. Ultimately, he told BusinessWeek, he hoped Tyco would "become the next General Electric."

But on Jan. 22, Corporate America's most aggressive dealmaker announced a shocker, laying out plans to dismantle the empire he built over the past decade with $62 billion worth of deals. By yearend, Kozlowski, 55, hopes to sell Tyco's plastics business to reduce debt, while splitting the rest of his $36 billion conglomerate into four separate, midsize companies.

Why quit now? The short answer is that Tyco's gunslinger has run out of ammunition. His stock has tumbled nearly 25% since the end of last year and now trades at just 12 times this year's expected earnings--a huge 50% discount to the multiple accorded the Standard & Poor's 500-stock index. So, Kozlowski would have found it hard to keep forking over paper for new purchases, making it difficult to meet his growth targets. "A company like Tyco makes sense when the market is willing to pay a premium over the underlying asset value, since that gives you a cheap currency for acquisitions," says Robert Monks, the famed shareholder activist who once served on Tyco's board of directors.

For years, it didn't matter to most investors whether they could figure out how Kozlowski was squeezing out double-digit growth from such mundane products as syringes and fire sprinklers. "Kozlowski, like [former General Electric CEO] Jack Welch, was defying gravity," says Michael Useem, professor of management at the Wharton School. Indeed, Kozlowski knit together such multibillion-dollar pieces as CIT, the nation's largest independent commercial finance company; AMP, a leader in electronic connectors; and ADT, the world leader in home security.

But with all the additions, it became nearly impossible to get an apples-to-apples comparison of Tyco's results over time. And now, post-Enron, investors aren't willing to stomach stocks that seem based on faith. Kozlowski may have built a GE-like conglomerate, but he never won the kind of credibility enjoyed by Welch. True, he beat back critics after an analyst set off a storm of stock-selling in October, 1999, with allegations that Kozlowski had pumped up earnings with accounting gimmicks. In mid-2000, the Securities & Exchange Commission ended an intense review without taking significant action. Tyco's shares quickly regained the ground they had lost and Kozlowski resumed his dealmaking. But Tyco's books remained a maze for all but the most persistent investors.

When Enron turned out to be hiding massive debt off its books, investors panicked and looked for other dominoes. They zeroed in on Tyco. "They're playing games" with their numbers, charges Albert T. Meyer, forensic accountant at David W. Tice & Associates Inc., the analytical firm that first raised serious questions about Tyco's accounting. The recent run on the stock was remarkably reminiscent of late 1999. But this time, Kozlowski found that it was nearly impossible to combat rumors--regardless of whether the charges had any merit. Sources close to the SEC took the unusual step of denying a report that the agency was launching a fresh probe of Tyco. It didn't matter. "When you don't fully understand something, you get a little worried," explains Charles L. Hill, director of research at First Call Corp. "And you get even more worried when you've just had the biggest bankruptcy in history."

Tyco's own statements were also raising new questions of whether it could maintain its pace. For the quarter ended Dec. 31, Tyco had to make a huge restatement of earnings because of an accounting-rule change that required the company to amortize earnings from sales of its security systems over time, rather than at the time of sale. That resulted in a cumulative downward adjustment of $654 million in earnings through Oct. 1, 2000.

Kozlowski was smart enough to realize the game was up. Still, a breakup seems unlikely to unleash the "50% upside" that he sees in Tyco's stock. It rose a paltry 2.4%, to $47.55, on the day of the announcement, and fell anew by 5% on Jan. 23. "I would not expect smooth sailing to successful execution" of Kozlowski's spin-off plan, warns Carol Levenson, an analyst at Gimme Credit, a bond-research firm based in Chicago. A key problem is that the managers who were named to run two of the Tyco spin-offs--health care and fire protection and flow control--are almost unknown. That raises doubts about whether the company can raise enough money from the initial public offerings to meet its goal of retiring $11 billion in debt. Critics also point out that partial IPOs will effectively dilute Tyco's shares. Kozlowski might fare better if he just sells some of the businesses to other companies.

Ironically, Tyco should be relatively easy to break up. It is highly decentralized, and each of the individual businesses is more than capable of prospering on its own. CIT, the first to be spun off, was a public company until last June. In fire protection, Tyco is the dominant player worldwide, and it is the world's second-largest maker of medical devices. And Kozlowksi will remain as CEO of the most troubled unit, the security and electronics business.

But even if Kozlowski sticks around, the Jan. 22 announcement marks a winding down of one of the most extraordinary corporate strategies of the past 10 years. He built an industrial conglomerate that grew like a high-tech star. In the new post-Enron environment, it may be a long while before we see another empire builder on this scale. Investors today are not only demanding performance--they also want to know what's behind it.

By William C. Symonds

With Diane Brady in New York

— With assistance by Diane Brady

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