Tyco gets good write-up
A Bold Bet
Troubled Tyco International looks unduly cheap to some noted
value investors
By ANDREW BARY
Tyco International has been one of biggest stock-market disasters of 2002. Its
shares, which peaked at 63 in early 2001, are down about 63% this year to 22,
cutting its market value to $44 billion from a high of $110 billion. Bad news has
piled up, leading to sharply reduced profit estimates for the current fiscal year,
which ends in September. Tyco has aborted a much-promoted plan to break the
company into four pieces, and investor confidence in Chief Executive Dennis
Kozlowski and his management team has eroded. In addition, Tyco faces liquidity
concerns prompted by its industrial businesses' $27 billion of debt and an
estimated $7 billion in scheduled bond and loan maturities during 2002. To date,
the company has been unable to sell its finance business, CIT Group.
Yet shares of the formerly acquisitive manufacturing and services conglomerate
may be nearing a bottom, assuming that Tyco successfully sells CIT or takes it
public in coming weeks, at or near the projected price of $6.5 billion -- and that
the company's accounting is clean.
Tyco International has attracted
some notable value-oriented
investors, including Bill Miller of
Legg Mason, Jim Gipson, head of
the Clipper mutual fund, and Leon
Cooperman, head of Omega
Advisors, a New York hedge fund.
Indeed, Tyco has become the topic
du jour among investment
professionals with a value bent. So
far, though, the stock has been a
value trap for Miller, Gipson and
Cooperman, all of whom bought
stock in the first quarter, when the
shares mostly traded above 30.
Several investors tell Barron's that Tyco looks appealing at current levels,
especially compared with industrial companies such as 3M, Danaher and Emerson
Electric, which now command much higher valuations.
"Tyco would be trading in the 30s if it simply got the multiple of the other
industrial names," says Alec Cutler, portfolio manager at Brandywine Asset
Management in Wilmington, Del., another Tyco holder. "All the others are pricing
in an economic recovery, and Tyco is discounting disaster."
"A lot of people are missing the point," says Bob Marcin, head of Marcin Asset
Management in Conshohocken, Pa. "Tyco was aggressive with its growth and
accounting, but it still has about $2 a share in earnings power. Tyco's not a sham
or a house of cards."
Barron's has been in the company's court for some time, dating back to a bullish
cover story in the spring of 1999 ("Tyco's Titan," April 12, 1999.)
At 22, Tyco trades for 11 times Marcin's fiscal 2002 earnings estimate of $2 a
share, giving it the lowest price/earnings multiple of any major industrial company,
and one of the lowest P/Es in the Standard & Poor's 500 index. 3M and Danaher
sell for 26 times projected 2002 profits, while Emerson fetches 21 times this
year's estimated net.
A profit estimate of $2 a share, reflecting $4 billion in net earnings, implies an
operating profit margin of about 14%, in line with companies such as Emerson
and Danaher.
Marcin's $2 estimate is below Tyco's own estimate of $2.60 to $2.70 a share in
operating profit for fiscal 2002. That's because he excludes CIT, which Tyco has
projected would contribute 55 cents in profit. Tyco's current estimate is down
from a projection of $3.70 a share as recently as January. The company has been
hurt by a sharp slowdown in its electronics and telecom businesses, as well as
what it has labeled "distractions" stemming from adverse publicity.
After write-offs, principally related to its troubled undersea fiber-optic business,
Tyco is expected to earn only $1 a share in fiscal 2002. That's quite a comedown
from the past five years, in which profit growth averaged a torrid 40% a year.
Tyco earned $2.80 a share in fiscal 2001, and $2.18 in the prior 12-month period.
Tyco now is aiming for a more reasonable 10% to 15% annual profit growth.
"Most people don't realize the kind of valuation you can get in this market with $2
a share in quality earnings," Marcin says. That same $2 regularly supports stock
prices of 40 to 50 if investors believe there's moderate growth potential. The
operative word, of course, is "quality."
Tyco's reported profits have been questioned amid reports that it has
"spring-loaded" earnings by forcing acquired companies to take big charges before
joining the fold. Too, there's talk that the company folds reserves from prior
restructuring charges into profits.
Tyco has said its accounting is
proper. Marcin thinks there's some
fluff in Tyco's reported results, but
that profits largely are clean. In
addition, Tyco's reported profits benefit from the company's Bermuda base,
which results in a low tax rate of around 20% -- about 15 percentage points below
peers.
After surprising Wall Street in January with a plan to separate into four
businesses, Tyco reversed course last month and decided to retain its industrial
businesses, which include electronics, fire and security systems, and health care
and specialty products. Instead, the company decided to unload CIT.
Tyco often is mentioned in the same breath as Enron, but there are some
important differences. Enron's earnings were dominated by trading profits that
turned out to be bogus, while Tyco is an amalgam of hundreds of companies
assembled by Kozlowski during the past 10 years. These real businesses include
the former AMP, U.S. Surgical, Mallinckrodt, and Raychem.
Tyco had a book value of $16.68 a share at the end of the March quarter. But
once goodwill and other intangibles, largely related to these acquisitions, are
stripped out, tangible book value shrinks to zero. Tyco's industrial businesses, all
that will remain after CIT is sold, are expected to generate $36 billion in sales in
fiscal 2002.
While Tyco faces a long road back into investors' good graces, there was some
good news last week. On a conference call with investors, Tyco Chief Financial
Officer Mark Swartz affirmed earnings estimates initially given last month for the
current quarter and fiscal year. Swartz also said a sale of CIT is on track, either
directly to a corporate or financial buyer or through the planned IPO. Tyco's
shares rallied almost $4 on the week.
In selling CIT, Tyco is backtracking on a badly timed acquisition that left both
Tyco and CIT vulnerable to liquidity fears earlier this year. These concerns shut
both out of the commercial-paper market, and forced CIT to draw down an $8.5
billion bank-credit line. Tyco paid $9.5 billion for CIT last June, then pumped
nearly $1 billion in additional capital into the business, which it had hoped would
blossom into another GE Capital, the finance arm of General Electric.
Tyco last month filed a preliminary prospectus for CIT, hoping to raise $6.5
billion. David King, manager of the Putnam New Value Fund, believes Tyco stock
could get a boost if the CIT IPO simply gets cleared by the Securities and
Exchange Commission. There has been talk that the deal might be held up at the
SEC, but some insiders tell Barron's it could be approved soon.
A successful CIT sale would go a long way toward easing liquidity fears, says
Nick Heymann, an analyst at Prudential Securities, who has been about the only
Street analyst writing critically about Tyco in recent months. Heymann was
cautious on the stock in the 30s and 40s but says it could trade into the mid-20s if
the CIT sale is completed. Heymann figures Tyco needs to get $5 billion from the
sale to pay off maturing debt this year, without any contribution from its operating
cash flow.
The CIT sale is hardly a sure thing,
given that potential buyers such as
General Electric and Berkshire
Hathaway are said to have looked at
CIT and refused to pay Tyco's $6.5
billion asking price. Warren Buffett
reportedly told Berkshire's annual
meeting that he passed on buying a
"large finance company" because of
"too many things that I didn't
understand."
On the surface, CIT looks like a steal
for $6.5 billion. After all, Tyco is
projecting more than $1 billion in net
income from the unit in the current fiscal year. This implies that CIT is asking just
six times estimated profits, which would make it the cheapest large financial
company in the market. Most financials trade for 10 to 20 times estimated 2002
profits. But many investors are skeptical about CIT's earnings and its asset quality.
Would-be buyers appear to be valuing CIT based on its tangible book value of a
little more than $4 billion. At 1.5 times book value, CIT would fetch around $6
billion. The talk in the market is that CIT may fetch only $5 billion to $5.5 billion.
Then there are loan-quality issues. Nonperforming assets have risen to 3.3% of
the portfolio, from 2.7% a year ago. CIT disclosed last week that its telecom loan
portfolio totaled $684 million on March 31. Nearly 9% of those loans aren't being
paid.
CIT also has a $3.9 billion commercial-aircraft portfolio. Kathy Shanley, of the
Gimme Credit newsletter, wrote recently that she fears CIT is "in denial about the
value of some of the assets in its portfolio."
An investment in Tyco clearly entails risks, but its fans are betting that the current
stock price provides a sufficient "margin of safety," to borrow a phrase from the
legendary Ben Graham. If Tyco demonstrates in the next year that it isn't an
accounting fraud and that its earnings power is $2 or more a share, its stock could
top 30 as investor fears subside.
...this week's barrons |
