Tyco International survived false accounting fraud accusations that nearly sank its high-flying stock last year. After a decade of diversification, can it now withstand an economic slowdown?
In nearly a decade as CEO, Dennis Kozlowski has built Tyco International from a $3 billion company focusing on fire prevention and flow control systems into a hulking, highly acquisitive, $29 billion conglomerate that sells everything from home security systems to health care products to electronic components. Tyco’s success in such disparate businesses, as well as Kozlowski’s reluctance to compete in industries where he can’t be a No. 1 or No. 2 player, has invited comparisons with General Electric Co. and its legendary CEO, Jack Welch.
Kozlowski is no wanna-be, but his methods are similar to Welch’s. Take Tyco’s announcement last month that it plans to buy commercial financing concern CIT Group for approximately $9 billion in cash and stock, a move which would give Tyco a financing arm similar to General Electric Capital Corp. Although the deal would take Tyco away from its traditional lines of business, Kozlowski says it should not be viewed as a precedent for further expansion beyond the company’s historical turf, but rather as a way to support those businesses by financing customer purchases.
By the numbers Kozlowski is doing even better than Welch: Tyco is growing faster than GE. The company earned $1 billion in the quarter ended December 31, an increase of 24 percent over the same period in 1999, while GE’s earnings grew by 16 percent. Analysts expect Tyco to continue to outpace GE in that department.
But the market doesn’t seem to be paying attention. GE shares trade for about 32 times trailing 12-month earnings, while Tyco’s carry a multiple of 16. Investors may still be hungover from the targeting of Tyco in October 1999 by short-seller David Tice, who accused the company of cooking its books. Regulators cleared Tyco, but not before its stock went reeling. Trading at more than $50 when Tice made his accusations, it declined by nearly 50 percent over the next two months. It was recently trading in the mid-50s before concerns about the CIT acquisition knocked about 10 points off the price.
With those allegations behind him, Kozlowski hopes that investors will recognize Tyco shares as undervalued. The true test may be in how the company performs amid the current economic downturn. Kozlowski has spent much of his time as CEO trying to diversify the company so that it is less susceptible to cyclical downturns. He says about 37 percent of Tyco’s revenues now are recurring, while some 40 percent come from outside the U.S. Both figures stood at less than 10 percent a decade ago. Kozlowski recently discussed the company’s outlook with Institutional Investor Staff Writer Justin Schack.
Institutional Investor: What have you done to make Tyco less of a cyclical play for investors?
Kozlowski: When I took over as CEO, at the time of the ’91-'92 recession, about 75 to 80 percent of our business was geared toward nonresidential construction - the fire prevention and flow control businesses. That’s now less than 5 percent of our business. We really put a strong emphasis on service and health care, which have long-term contracts and recurring revenues, like monthly bills for ADT security systems or replacement parts. We also entered the electronics business, which in good times grows by 40 or 50 percent annually but in bad times still grows by about 15 or 20 percent, which isn’t bad.
How many acquisitions have you made as CEO?
Wow. Hundreds. Probably around 400.
How have you had so many deals succeed when experts estimate that more than two thirds of mergers fail?
We look as soon as we announce a deal at what costs we can take out during the first 30 days. We know we’re not going to get it 100 percent right, but we’re satisfied to get about 80 or 90 percent in a relatively short period of time, as opposed to studying it for many months and during that time losing good people in the acquired company. We also have the operating people involved right from the start. Once we have the costs out, we put our emphasis on revenue enhancements. No company has ever cut its way to greatness. But we never price [revenue growth] into a deal. If you justify the deal only on the cost reductions - and you never get any revenue enhancement - you’re still in the black.
Taking that disciplined approach right from the get-go must scare away some potential targets.
Oh yeah, sure. Fourteen out of 15 deals we look at don’t happen.
Do you foresee a day when you are going to run out of targets?
No. It’s a big planet. There’s a lot we can acquire. There are enough companies out there that make sense for us that we could double the size of Tyco if we were to effect these acquisitions. Most of those won’t happen, but over time some of them will. If we run out of targets, then we’re operating a company that’s growing in double digits organically, regardless of how the economy is performing, and that is generating between $4 billion and $5 billion a year in free cash.
Tyco stock is cheap compared with that of some companies with lower earnings growth. Why?
I think that the multiple of the stock should improve as we show during down cycles that we can continue to grow our earnings. The stock has doubled in price in the past 12 months. Of course, it had been beaten down because of the false accounting accusations that came our way, of which we were cleared by the Securities and Exchange Commission last summer. With that behind us, I think investors will focus on our performance, and the multiples will catch up with us.
What do you think of when you hear David Tice’s name?
I think he’s a short-seller who saw an opportunity to go after a company with a high multiple, who made up some stuff and made us into one of the more scrutinized companies in the world.
How will the new Financial Accounting Standards Board rules on merger accounting affect you?
We like it because it puts us closer to cash flow per share, which we believe is a good way of valuing companies. We have no impairment of any of our goodwill from previous acquisitions, because our cash flow is very close to the operating earnings of the company. So I think we pick up about 20 to 30 cents a share by not having to amortize [goodwill]. With the new changes to purchase accounting, you get the benefits of pooling without the restrictions on share buybacks or disposition of assets that pooling prevents you from doing.
Why did you spin off TyCom, your undersea cable unit?
It was better for our shareholders to spin it off because it received a higher multiple than Tyco’s. The second part was to raise cash to fund the deployment of our undersea fiber-optic cable system, which we’re building ourselves for our own account. The third benefit is that having a more highly valued currency than Tyco stock helps us recruit the scientists we need for that business.
Will there be more spin-offs?
There was one other potential spin-off that we were considering but never took any action on, in the electronics area. The market conditions where they are, we don’t anticipate any other spin-offs.
Where might you expand globally?
We see opportunities for growth in Europe, in North America, in Southeast Asia. We have done some acquisitions in Japan.
Has any of these regions been more challenging than another?
We have nationals on the ground everywhere. We don’t use expats to run our businesses. As a result, our people know the business, the culture, the way of life. It’s the same to us if we’re supporting a manager in Belgium, the U.K., Singapore or Tokyo as it is if we’re supporting a manager in Massachusetts or Pennsylvania.
Have you ever had an acquisition backfire?
Yeah, back in the early 1990s we acquired a company called National Pipe & Tube Co. and decided to get into the business of manufacturing pipe that is used in mechanical systems. We figured we would make the products and put them through our own distribution systems. But we found we could not purchase raw materials competitively or convert enough of them competitively to keep prices where they needed to be. We were still going to be No. 5 or 6 in the business. We had a mess on our hands and ended up selling it. The lesson learned there is you really want to be No. 1 or No. 2 in any business. No matter how good it looks on paper, the big players in the industry will really come down on you if you’re not No. 1 or No. 2.
How has the current economic slowdown affected Tyco?
Health care, fire security and flow control have remained strong. We saw a slowdown in some segments of our electronics business by around September. And we saw a little bit of softness in U.S. automotive. Recently, things seem to be improving a little bit.
