Is Tyco Looking at a Fire Sale?
In the elite world of yacht racing, Tyco International (TYC ) CEO L. Dennis Kozlowski is known for his ability to navigate rough seas. But the captain of America's most ambitious conglomerate has never faced gale-force winds like these. Just two weeks after he unveiled a surprise plan to break up Tyco into four midsize companies, investors and bondholders alike were jumping ship in sheer panic. The move was sparked by fears of an impending cash crunch, after Tyco and its finance arm, CIT, announced they would swap all their $13 billion in commercial paper for more expensive bank debt. Both had been effectively shut out of the commercial paper market--leaving even big fund companies saying "let's shoot first and ask questions later," says an analyst at one institutional holder.
The question now is whether Kozlowski can regain control in time to salvage Tyco's underlying value. He took a small step in that direction on Feb. 6, announcing that rather than waiting for a public offering, Tyco will spin off CIT to shareholders within 8 to 12 weeks. And it will move even sooner if it gets a better offer from one of its potential bidders, possibly General Electric Co. That news boosted the stock $2.83, to $25.93--finally ending a slide that sent shares down from $59 on Dec. 31. Fears about Tyco's opaque accounting had branded it "the next Enron," vaporizing more than $60 billion in market value.
A successful spin-off or sale of CIT is needed to head off a potential cash squeeze at Tyco's finance arm. The company has $12.5 billion in commercial paper and other debt obligations coming due just through June. CIT says that between an $8.5 billion bank line it tapped and about $5 billion more in securitization facilities, it is covered for five months or so. But the company, which was the nation's largest independent commercial-finance outfit before Tyco bought it, has enormous financing needs. "There is less confidence in us, and that poses terrific issues," says CIT CEO Al Gamper Jr.
Even without CIT, Kozlowski still must deal with a mountain of debt left over from the $63 billion acquisition binge he has indulged in since 1995. As of Dec. 31, Tyco's industrial companies had $28.3 billion in debt, according to Standard & Poor's, up from just $20 billion last March. The swap to bank credit should cover Tyco's debt obligations for the next year. But combined with CIT's similar move, it also will cut earnings up to $300 million this year, due to higher interest costs, Kozlowski admits. Worse, it signals that the debt clock is ticking. "They have diminished financial flexibility," even as they have more than $9 billion of debt still coming due next year, says Cynthia M. Werneth, an analyst at S&P, which cut Tyco's debt rating three notches, to BBB, on Feb. 4.
Kozlowski has long argued that he has plenty of cash coming in to meet Tyco's ongoing financial needs. "There is a crisis of confidence, but there is no cash crisis," he insisted in the Feb. 6 conference call. But Tyco likes to use an unusually generous definition of cash flow. In the fiscal year ended Sept. 30, it reported $4.75 billion in "free cash flow." But that didn't count more than $2 billion it spent to build the massive Tycom undersea global-telecom network. Subtract that, and Tyco had just $2.5 billion in cash flow, figures S&P's Werneth. Nor did it count some $900 million spent on "purchase accounting liabilities," or acquisition-related costs such as layoffs. Subtract those, and free cash drops to just $1.6 billion, argues Albert J. Meyer, an analyst at David W. Tice & Associates Inc., a frequent critic of Tyco's accounting.
Meyer is equally skeptical of Kozlowski's claim that Tyco will generate $4 billion in cash flow this year. Kozlowski brandished the same number a month ago, while predicting Tyco would earn $3.70 a share this year. Yet now he admits earnings could come in 45 cents--or some $900 million--lower, due to higher interest costs and new weakness in its depressed electronics unit.
With Tyco unable to tap equity or debt markets, Kozlowski has little choice but to sell off his businesses. After CIT, the next to go will likely be Tyco's plastics units, which make everything from garbage bags to coat hangers. "There's an awful lot of interest" in those businesses, says Kozlowski, who hopes to announce a deal by spring. Problem is, Tyco is in no position to run an orderly auction. And given the bull-market prices it paid for many acquisitions, it could book losses on many of the sales. That's particularly true of CIT, for which it paid $10 billion last June, warns Barry B. Bannister, a Legg Mason Inc. analyst. Another investment banker says Tyco "won't come close" to fetching the $3 billion Kozlowski wants for plastics. "We think it's more likely a fire sale" will occur now, he adds. Tyco is adrift in a steadily pounding sea, with little letup in sight.
By William C. Symonds in Boston, with Emily Thornton in New York
— With assistance by Emily Thornton