Solving Tyco's Identity Crisis

CEO Ed Breen has restored credibility. Now the hard part: Making sense of its mishmash of businesses

Edward D. Breen has worked hard to clean up the mess Dennis Kozlowski left at Tyco International (TYC). Now, Breen faces an even harder job: proving he can run Tyco's diverse businesses.

When Breen arrived in mid-2002, Tyco was a $40 billion empire constructed for all the wrong reasons—size without strategy, dealmaking without management. By the time Kozlowski was indicted for pilfering money from the company coffers, Tyco had taken massive asset writedowns, it faced a looming debt crunch, and its accounting was in question. (It was determined "aggressive" by regulators, but not fraudulent.)

Indeed, Breen has been on the crisis management beat since his first day on the job. In the past five years, he and his team have replaced the board and much of the senior management, hacked three-quarters off the debt load, settled most of the outstanding shareholder lawsuits, and restored Tyco's credibility in the eyes of creditors, investors, and its own employees.

Through all the triage, the new management team tried to make sense of the complex tangle of businesses Kozlowski had thrown together. The coup de grâce on the scandal-plagued era came last June as Kozlowski was serving his 8-to-25-year term in federal prison. Breen broke Tyco into three parts, spinning off the health-care division, now called Covidien (COV), and the Tyco Electronics (TEL) unit as independent entities. The moves helped, but as the chairman and chief executive of the new Tyco International, Breen is still left with a fundamental question: Why does Tyco exist? "It is a collection of decent businesses," says Robert E. Mittelstaedt Jr., dean of the W.P. Carey School of Business at Arizona State University. "The question is, do they make sense [together] going forward?"

KEEPING EXPECTATIONS LOW

Starting from scratch, Breen probably wouldn't have drawn up his current portfolio of businesses. If Tyco was a sprawling $40 billion conglomerate in 2002, today what Breen reflexively calls "new Tyco" is a slightly less sprawling $18 billion conglomerate. It includes: security business ADT, a fire protection unit, a red-hot valve business, safety products manufacturing, and an industrial metals operation (table). The leftovers do have a financial affinity, says Breen—all generate healthy cash flow ($800 million in 2007), have recurring rev-enue, and require relatively low capital investment. (Research and development last year, for example, was just $121 million.) But the pruning isn't done: "We're going to exit businesses," says Breen, who adds that his goal is to focus tightly on security, fire, and valves.

The sort of existential anxiety Tyco must deal with is a fact of life for any conglomerate. (No one has to ask Nike (NKE) what it does for a living.) And each successful one, from a titan like General Electric (GE) to smaller ones like Emerson Electric (EMR) or Danaher (DHR), has a different strategic rationale for its collection of businesses. "There are plenty of companies that exist successfully at the size of Tyco," says Nicole Parent, a multi-industry company analyst at Credit Suisse (CS). "What weaves them together is the operating culture."

The problem for Breen is that no one is quite sure what the operating culture at Tyco looks like. That's because the company has spent much of the past five years assuaging creditors, quelling lawsuits, and dealing with Securities & Exchange Commission inquiries. "The current management team has been focused on nonoperational issues," says Parent. "The underlying task at hand has changed dramatically."

So far, investors have been slow to latch on to the new Tyco's story. "I don't think it has fully gotten traction," Breen admits. Since the spin-offs last June 29, Tyco shares are down 22%, trading at a recent 41. Similarly sized conglomerate Danaher's shares have slipped just 4%, while Emerson Electric has seen shares tick up 6%. Analysts on Wall Street have taken a wait-and-see approach, with half of the 14 rating Tyco "hold" or "sell."

Diversified peers, of course, have historical legacies and years of management tradition to guide them. Tyco's past, by contrast, is of little use to Breen. Indeed, one of his first points of order was to sweep the company of many of its deal-frenzied, Kozlowski-era managers. "They were private-equity-type people," Breen says. "When I first got here, I'd talk about, 'We're not doing any more acquisitions, we're going to focus on operational execution.' Some of them, I could just watch their eyes roll up in their head." He says he has replaced more than half of the company's senior management.

So far, in just two quarters of "new Tyco," Breen has tried to keep expectations low as the company refocuses on operations. On Feb. 5, Tyco showed progress on that front, reporting $369 million in first-quarter operating income, more than double the prior first quarter, on $4.9 billion in sales, a 12% increase. Net income, because of restructuring charges and a higher tax bill, fell by half. The results easily outpaced analysts' subdued estimates: They "perhaps reflect better business quality than many have been assuming," wrote JPMorgan (JPM) analyst Stephen Tusa in a note to clients.

The days ahead won't be as exciting as the deal-a-minute Kozlowski regime. Breen sees room to push for operational improvements at the business lines: "This company did over 600 [deals] and didn't integrate them," he says. Tyco's Earth Tech infrastructure business is already on the block and is expected to fetch more than $1 billion. Kozlowski's legacy is fixed. Clearly, Breen's is still a work in progress.

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