Tyco: A Hot Prospect, or Radioactive?
By Amy Tsao
The debate continues over whether it's time to pick up shares in troubled conglomerate Tyco. The stock looks tempting at its Oct. 4 close of $13.05, down dramatically from its 52-week high of $60 but up from a low of $7 hit in late July when rumors swirled that Tyco (TYC ) was headed for bankruptcy. That speculation has been put to rest for now, and the stock's current level reflects a stunningly low price-to-earnings ratio of 7.5 times fiscal 2003 consensus earnings of $1.72 per share.
Even Legg Mason Value Trust's Bill Miller, a noted value investor who was named Morningstar's fund manager of the decade for the 1990s, had been scooping up Tyco earlier in 2002. As of June 30, the fund held 24.1 million of its shares. Legg Mason declined to comment on whether it has bought or sold any shares since then. But even a seeming vote of confidence like that doesn't erase the fact that Tyco has some serious problems that won't go away anytime soon. And that makes buying the stock, even at a depressed price, a high-risk proposition.
Skeptics continue to worry about what investigations into Tyco's books might reveal. Beyond the sluggish U.S. economy, other concerns include a cutback in acquisitions -- which virtually guarantees that Tyco will have slower growth -- and its mountain of debt.
Newly appointed CEO Edward Breen, who's credited with implementing a successful cost-cutting program while at Motorola, has reassured investors that Tyco is working to reform itself. "We have a bright, bright future in front of us," Breen said during a Sept. 25 conference call.
However, Tyco's past financial statements and accounting methods are the subjects of an internal probe and another by the Securities & Exchange Commission, which began in June amid allegations that ex-CEO Dennis Kozlowski had evaded sales tax in New York. The internal review isn't even half-finished, and until it and the outside investigations are wrapped up, Tyco's prospects will remain difficult to pin down.
"I can't really defend where buyers of Tyco stock are coming from. I don't know where they're getting good solid numbers from," says Peter Cohan, president of consultant Peter S. Cohan & Associates. "Valuation is not the issue," says one analyst, who requests anonymity. "It's a clear value story. The problem is that we still don't know what's going to happen. If you don't have trust in the accounting, then what's the point?"
Tony Maramarco, portfolio manager of the Babson Value Fund, echoes that sentiment: "There are too many unresolved questions. We're going to sit back and watch and not become involved." Tyco declined to comment for this story.
Given that Tyco has some $26 billion in long-term debt, it's clear that the difficult economy is making life even harder for the beleaguered outfit. Tyco says it needs $1.5 billion to $2 billion to meet debt obligations due in 2003. Prudential Securities' Nicholas Heymann figures that this number could be closer to $2.5 billion or $3 billion when costs like pension-plan contributions and cash restructuring expenses are factored in.
He fears that any restatement as a result of investigations would add more costs. "This really isn't that complex a story anymore," says Heymann, who rates the stock a hold. "We just have to wait and see that the company gets adequately liquid to meet any debt coming due or debt that could be triggered between now and next November."
BIGGER TAX BITE.
Tyco's business lines face mixed prospects, at best. Its biggest business, electronics, is under pressure. And it'll take a $2 billion to $2.5 billion charge to restructure Tycom, its struggling undersea-cable division. Breen says for the fourth quarter ended Sept. 30, Tyco saw ongoing softness for both electronics and telecom, while health-care and engineered products were in line with expectations of modest growth. The home-security systems business grew at a slower pace as Tyco spent less on acquisitions. Breen has notched down 2003 earnings expectations to a range of $1.50 to $2 per share, from $2.10 to $2.20.
Changes in Tyco's tax structure will also hurt its profits. Previous earnings-per-share guidance for the fourth quarter was lowered by a third, to a range of 30 cents to 33 cents from 45 cents to 47 cents. Because Tyco now has fewer tax-deductible intercompany loans, it expects to pay taxes for fiscal 2002 at a higher rate -- 22% vs. 18.5% . This change alone will account for 8 cents of the EPS reduction forecast for the quarter.
Many Wall Street analysts figure that Tyco has been unfairly punished and that Breen will be able to steer it back to financial health. Merrill Lynch estimates that in 2003 Tyco will report total sales of $36.5 billion, about the same as in 2002. Still, Merrill analyst John Inch, who follows Tyco, rates the stock a buy and figures it can reach $25.
3M, NOT GE.
Even if Inch and those of his ilk are right, Tyco shares will attract a crowd very different from the growth investors who lauded Kozlowski's efforts to make Tyco a General Electric-style powerhouse. With the acquisitions pace halted, Tyco's growth will more closely resemble that of conglomerate peers 3M, with margins that are less spectacular than GE's.
Over the long haul, Tyco likely will stabilize. But until then, its enticingly low valuation probably won't be enough to lure investors from the sidelines.
Tsao covers financial markets for BusinessWeek Online in New York
Edited by Beth Belton