Kozlowski's Out, but Some Worry His Vision Lingers

Updated from 3:08 p.m. EDT

Rarely has a company been more closely identified with its chief executive than Tyco International(TYC Quote). And rarely has the association seemed like such a liability.

Dennis Kozlowski was ousted from the helm of Tyco Monday amid reports that he is under criminal investigation for avoiding New York sales tax. A federal grand jury is exploring whether Kozlowski moved hundreds of millions of dollars into family trusts and used those trusts to buy goods and services without paying state sales taxes, according to The New York Times.

"The market is taking this as an indication that if [Dennis Kozlowski] were somewhat devious as a person, then they're extending that to the company," said Brett Gallagher, head of U.S. equities at Julius Baer Investment Management.

Critical Mass

For shareholders, the news lent credence to other allegations surrounding the firm's dubious accounting practices, and they bid the stock down 27% to close at $16.05. Tyco has come under intense scrutiny this year for the way it has accounted for and disclosed a series of acquisitions that fueled the firm's rapid growth and built it into one of the biggest conglomerates in the world.

Salomon Smith Barney analyst Jeffrey Sprague downgraded the stock to neutral from buy Monday, saying that while he has been a strong supporter of Tyco and believes there is significant value in its business, the resignation could rattle suppliers and customers and further disrupt business.

He also noted that other management departures are likely and that the questions surrounding Kozlowski's departure may hinder the firm's ability to complete its restructuring. Salomon has had an investment banking relationship with Tyco in the last 12 months.

In a press release, Tyco reiterated its intention to complete its planned IPO of financial services unit CIT, but observers say a sale will be more difficult now.

"Anyone who would have been a buyer now has to reassess whether they want to get involved and at what price," Gallagher noted.

Misfiring

Two weeks ago Lehman Brothers (LEH Quote) backed away from a $5 billion acquisition of CIT when word of the offer was leaked to the press. A sale or spinoff of the unit is expected by the end of this month.

Gallagher said Tyco may be forced to sell CIT at a significant discount to entice buyers, which could further reduce the amount of debt that the company is able to pay down. The firm has $5.5 billion in debt due this year and $9 billion due next year, according to Gallagher.

Tyco has said it hopes the CIT sale and current cash flow would enable it to pay off $10 billion in debt, reducing all outstanding debt to $17 billion from $27 billion. Analysts have estimated that Tyco will receive between $5 billion and $7 billion from the unit.

"Until Tyco has cash in hand from CIT, there's no point discussing the fundamentals or anything else," said Nicholas Heyman, an analyst at Prudential Securities. "We thought there would be some management changes, but we thought they'd come after CIT had been monetized."

Standard & Poor's said in a statement that it would maintain its BBB debt rating on Tyco and leave the company on creditwatch. S&P analyst Cynthia Werneth has said in the past that if the IPO is successful, Tyco should have enough liquidity over the next 18 months to meet scheduled and potential public and bank debt maturities.

If it is unsuccessful, however, she said Tyco could be forced to seek alternative financing arrangements to meet financial obligations during calendar 2003, heightening refinancing risk.

Contingencies

S&P has also said that it would raise Tyco's short- and long-term ratings if CIT was sold quickly, but would consider lowering the firm's rating if access to the capital markets became more difficult.

"If we were to have a downgrade, that complicates things further because on the bond side, there's a whole world that can only own investment grade credit," Gallagher said. "Even if this all amounts to nothing, perception is sometimes more powerful than reality."

In an attempt to mitigate concerns about its complex accounting methods, Tyco said in January that it would split into four separate units. But it abandoned that strategy in April with Kozlowski telling shareholders that the plan had been a "mistake." The flipflop sent shares plummeting and sparked calls for Kozlowski's resignation. Tyco has now lost almost 73% since the start of the year.

A former Tyco chairman, John Fort, will assume executive responsibilities until a replacement for Kozlowski can be found. Fort served as Tyco chairman and CEO from 1982 to 1992. Since 1992, he has been an active member of the board and he is currently the lead director, acting as the primary liaison between management and the outside directors.