Commentary: A To-Do List for Tyco's CEO

By William C. Symonds

By the time Edward D. Breen took the reins as the new CEO of Tyco International Ltd. (TYC ), on July 29, he had already received what passes for a hero's welcome on Wall Street: In the two trading days after the surprise announcement that he was resigning as president and COO of Motorola Inc. to head the troubled Bermuda conglomerate, Tyco's stock soared 53%, adding a neat $9 billion to its market value.

But the honeymoon could be short-lived unless Breen, 46, uses his mandate to quickly embark on a sweeping transformation of the $36-billion giant. Breen's first priority will be to win back investors' trust, badly eroded by the previous management's aggressive accounting, indiscriminate acquisitions, strategic missteps, evasion of U.S. taxes, and disregard for minimal standards of corporate governance.

Beyond that, Breen will have to squeeze growth from a company engaged in a range of prosaic industrial businesses that, while profitable, are facing declining margins. Without the rapid-fire dealmaking favored by Breen's predecessor, Dennis Kozlowski, Tyco can't report the kind of blistering results of the past. Still, most analysts believe Tyco can earn some $4 billion on sales of $38 billion next year, a decent return for a cyclical industrial manufacturer "A company like that should be worth 11 or 12 times earnings," or twice today's levels, argues Kevin McCloskey, a portfolio manager at Federated Investors Inc., which is keeping its stake of 5 million-plus shares.

Much depends on Breen's abilities as a manager and turnaround artist. His appointment was almost universally hailed. In a career that has included a stint as CEO and chairman of the cable-equipment maker General Instrument Corp., as well as the No. 2 job at Motorola, he has "an outstanding reputation as an excellent operating manager well-versed in restructuring and turnaround for manufacturing businessess," says Nicholas Heymann, an analyst at Prudential Financial.

Breen's first task will be to clean house, starting with the board. "The credibility of the old guard is gone," says David Dreman, chairman of investor Dreman Value Management LLC. The board remains packed with such veterans as former Tyco CEO John F. Fort, who helped groom Koz-lowski, and former ADT Chairman Michael Ashcroft, one of the first to discover the merits of a Bermuda base. Breen also needs a new executive team. The current crop is too closely linked with Kozlowski to effectively implement the radically different strategy Tyco needs today.

After more than two years of controversy over Tyco's accounting, Breen also needs to move quickly to restore faith in its numbers. Even now, Tyco is still trumpeting discredited pro-forma results and unusually generous measures of cash flow. Breen should bring in respected outsiders to develop strict, conservative accounting procedures. Quickly resolving investigations by the Securities & Exchange Commission and other authorities is also essential.

Breen's final urgent priority is eliminating fears of a liquidity crunch. Despite rumors of impending bankruptcy, debt analyst Eric Ause of Fitch Ratings doesn't believe Tyco faces an immediate crisis, since it has over $7 billion of cash. But even Tyco concedes it faces a $1.5 billion shortfall in paying off $12 billion-plus of debt coming due by the end of next year. And that assumes free cash flow of $4 billion in the coming fiscal year, up from a projected $2.5 billion this year. With margins at virtually all of Tyco's businesses under pressure, that won't be easy.

To raise cash and rebuild Tyco's balance sheet, Breen must move aggressively to pay down debt by cutting costs and sell some businesses. Even in today's market, "there'd be a number of buyers" for pieces of Tyco's highly competitive medical device companies, says Merrill Lynch & Co. analyst John G. Inch. Once Breen has weeded his portfolio, Dreman figures Tyco's industrial holdings should be able to generate earnings growth of 7% a year, equal to the long-run performance of the Standard & Poor's 500-stock index.

To be sure, Breen could be blindsided if ongoing investigations turn up deeper problems with Tyco's accounting--forcing a restatement and possibly sparking a liquidity crisis. Barring that, Tyco is hardly doomed. This is a company that can be saved.

Symonds is Boston bureau chief.

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