((This was copied from Auric's thread....))
Jim Chanos, Part II: " Doubting Tyco
-- Jonathan R. Laing, Barrons
Jim Chanos finds no dearth of short-selling ideas in the post-Enron stockmarket. Wall Street's new-found abhorrence of opaque accounting, he says,will hasten the decline in the stocks of a number a firms that are using
aggressive accounting methods to boost reported earnings.
Among his current shorts are lenders with large exposures to the sub-prime credit market, including Household International, the consumer-finance giant ("Does It Add Up?" December 3, 2001), as well as Metris and Capital One,
both credit-card firms. A rotten economy has exposed their borrower base to hard times, says Chanos, and high lending rates and fat lending margins won't be enough to insulate the firms from rising credit losses. Rapid growth in loan
receivables at all three companies, can only mask the rising delinquency rates for so long, he says. The growing deterioration in sub-prime lending, it should be noted, has already laid low other former Chanos shorts, including
AmeriCredit, Conseco and Providian. The sector has also engaged in aggressive accounting to burnish current results.
Chanos is also short the stock of Bally Total Fitness. The health-club concern, he says, is being hurt by flattening membership growth and high capital spending requirements to keep club equipment up-to-date. As a result, cash flow, including maintenance capital spending, remains negative even after the company recently slowed its expansion drive.
But his latest jihad is against the industrial-conglomerate Tyco International, which he began shorting late last year in the high 50s. The company's stock is now trading at around 45, hurt by a lowering in its guidance for earnings
growth in the fiscal second quarter, ending March 30, 2002, and the Enron-inspired disaffection for companies with complicated financials.
Jim Chanos' Picks
Company
Symbol
Recent Price
Bally Total Fitness
BFT
$21.72
Capital One
COF
52.70
Household Intl
HI
53.75
Metris
MXT
18.28
Tyco Intl
TYC
44.37
Chanos argues that the hyper-acquisitive Tyco has used accounting legerdemain to turbocharge earnings growth, which topped 40% annually for the five years through fiscal 2000, and came in at 28% last year. He claims, for example, that that the managements of several firms that Tyco aquired, including medical-supply company US Surgical, electronic-components maker AMP and finance-company CIT Group, all artificially depressed the operating results of their companies in the final months before the deals were
completed. This was done by taking numerous charges, slowing down sales and pushing up expenses. As a result, he says, Tyco's operating results were "spring-loaded" for a quarter or two after the acquisition closed, as sales
suddenly surged and profit margins exploded.
Chanos also contends that Tyco abused accounting rules by essentially writing down the net asset value to zero of some $30 billion in acquisitions made in the last three years. Thus, the purchase prices were all allocated to goodwill on the balance sheet. This intangible asset was amortized over a 40-year period as compared to, say, property, plant and equipment that must be expensed on the income statement over far shorter depreciation periods.
Under new accounting regulations, the earnings hit from goodwill has all but disappeared.
This is the second holy war that Chanos and the other major shorts have waged against Tyco. In late 1999, they raised questions about other aspects of Tyco's acquisition accounting. The stock swooned for a time before smartly recovering in mid-2000 after the SEC gave the company a clean bill of health on the accounting issue. Tyco was only required to make a few minor adjustments to its acquisition reserves and restructuring charges from earlier years.
Barron's published a bullish cover story, "Tyco's Titan" in the April 12, 1999, issue, profiling Tyco's hard-charging chairman Dennis Kozlowski. Among other things, we examined Tyco's complicated financial reporting and concluded that their accounting appeared to pass muster. The company, then
and since, has enjoyed strong growth in free cash flow, or cash flow after all required capital spending. That number, which reached nearly $5 billion in fiscal 2001, is a difficult one to fake. The stock ultimately rose to over 60 late last year from a split-adjusted 38 when the Barron's story appeared. Yet Tyco stunned the investment community last week by announcing plans to break up the company into four pieces: security and electronic components; fire-protection and flow controls; health care and financial services. Moreover, Tyco hopes to cuts its $23 billion debt in its non-finance operations by $11 billion by using proceeds from the initial public offerings of three of the new units and the sale of Tyco's plastics business. Last week, Kozlowski told Barron's that the breakup grew out of management's dissatisfaction with the stock's low price-to-earnings ratio (now below 12 based on fiscal '02 estimates) and a post-Enron need to simplify financial reporting by simplifying business structures. "After being a fast-growing
conglomerate over the past decade, it's clear now that we can deliver more value to the shareholder by breaking up," Kozlowski contends. He puts the breakup value of Tyco at between 75 and 90. The sudden shift in Tyco's management philosophy didn't initially boost the stock, however. Late
in the week, it was trading around 44, or nearly 2 1/2 points below where it had stood before the breakup announcement. Chanos says that he sold more Tyco short on the day of the announcement, during which the price initially spiked up more than four points before settling back.It remains to be seen who's right, Kozlowski or Chanos. We should know within the next year, however, when the breakup is expected to be completed. |
